capital market product
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1
PROJECT REPORT ON
CAPITAL MARKET PRODUCT
IN PARTIAL FULFILMENT OF
THE DEGREE AWARDED AT
BCOM (FINANCIAL MARKET)
SEMESTER-V
SUBMITTED TO
UNIVERSITY OF MUMBAI
FOR THE ACADEMIC YEAR 2015-2016
SUBMITTED BY
NAME TEJAS PAWASKAR
ROLL30
VIVA COLLEGE OF ARTS COMMERCE AND SCIENCE
VIRAR (WEST)
401303
2
PROJECT REPORT ON
CAPITAL MARKET PRODUCT
IN PARTIAL FULFILMENT OF
THE DEGREE AWARDED AT
BCOM (FINANCIAL MARKET)
SEMESTER-V
SUBMITTED TO
UNIVERSITY OF MUMBAI
FOR THE ACADEMIC YEAR 2015-2016
SUBMITTED BY
NAME TEJAS PAWASKAR
ROLL30
VIVA COLLEGE OF ARTS COMMERCE AND SCIENCE
VIRAR (WEST)
401303
3
DECLARATION
I hereby declare that the project CAPTIAL MARKET PRODUCT is an original work
prepared by me and is being submitted to UNIVERSITY OF MUMBAI in partial fulfillment of
the degree awarded at BCOM(FINANCAIL MARKET) for the academic year 2015-2016
To the best of my knowledge this report is not been submitted earlier to the university of
Mumbai or any other affiliated college for the fulfillment of BCom (FINANCIAL MARKETS)
degree
Date Name TEJAS PAWASKAR
Place Signature
4
ACKNOWLEDGEMENT
1TEJAS PAWASKAR the student of VIVA collage persuing my degree at
BCOM(FINANCIAL MARKET) would like to pay the credit for all those who helped me in
making project
The first in accomplishment of this project is our Principal DR R D Bhagat Vice Principal
Prof Prajakta Paranjape and project guide Prof RAKHEE OZA and course co-coordinator
Prof VASANTHI R Shenoy
I would like to thank of my friend teacher non-teaching staff who influence directly and
indirectly in making this project to me
5
INDEX
SR
NO
TOPIC PAGE
NO
1 CAPTIAL MARKET PRODUCT 6
2 CO-OPERATE SECURITIES 9
3 DERIVATIVES 20
4 FUTUREFORWARDAND OPTION 24
5 COMMODITY DERIVATIVES 32
6 BONDS 35
7 SHARES 38
8 COLLECTIVE INVESTMENTS SCHEME 40
9 DEBENTURE 43
10 SECURTY IN DIFFERENT JURISDICTIONS 44
11 CONCLUSION 45
12 BIBLIOGRAPHY 46
6
1CAPITAL MARKET PRODUCT
What are financial markets
Financial market is a market where financial instruments are exchanged or traded and
helps in determining the prices of the assets that are traded in and is also called the price
discovery process
1 Organizations that facilitate the trade in financial products For eg Stock exchanges
(NYSE Nasdaq) facilitate the trade in stocks bonds and warrants
2 Coming together of buyer and sellers at a common platform to trade financial products
is termed as financial markets ie stocks and shares are traded between buyers and
sellers in a number of ways including the use of stock exchanges directly between
buyers and sellers etc
Financial markets may be classified on the basis of
bull types of claims ndash debt and equity markets
bull maturity ndash money market and capital market
bull trade ndash spot market and delivery market
bull deals in financial claims ndash primary market and secondary market
Indian Financial Market consists of the following markets
bull Capital Market Securities Market
o Primary capital market
o Secondary capital market
bull Money Market
bull Debt Market
7
Capital market and money market
Financial markets can broadly be divided into money and capital market
Money Market Money market is a market for debt securities that pay off in the short term
usually less than one year for example the market for 90-days treasury bills This market
encompasses the trading and issuance of short term non equity debt instruments including
treasury bills commercial papers bankers acceptance certificates of deposits etc
Capital Market Capital market is a market for long-term debt and equity shares In this
market the capital funds comprising of both equity and debt are issued and traded This
also includes private placement sources of debt and equity as well as organized markets
like stock exchanges Capital market includes financial instruments with more than one
year maturity
Significance of Capital Markets
A well functioning stock market may help the development process in an economy
through the following channels
1 Growth of savings
2 Efficient allocation of investment resources
3 Better utilization of the existing resources
In market economy like India financial market institutions provide the avenue by which
long-term savings are mobilized and channeled into investments Confidence of the
investors in the market is imperative for the growth and development of the market For
any stock market the market Indices is the barometer of its performance and reflects the
prevailing sentiments of the entire economy Stock index is created to provide investors
with the information regarding the average share price in the stock market The ups and
8
downs in the index represent the movement of the equity market These indices need to
represent the return obtained by typical portfolios in the country
Generally the stock price of any company is vulnerable to three types of news
bull Company specific
bull Industry specific
bull Economy specific
An all share index includes stocks from all the sectors of the economy and thus cancels
out the stock and sector specific news and events that affect stock prices (law of portfolio
diversification) and reflect the overall performance of the companyequity market and the
news affecting it
The most important use of an equity market index is as a benchmark for a portfolio of
stocks All diversified portfolios belonging either to retail investors or mutual funds use
the common stock index as a yardstick for their returns Indices are useful in modern
financial application of derivatives
Capital Market Instruments ndash
some of the capital market instruments are
bull Equity
bull Preference shares
bull Debenture Bonds
bull ADRs GDRs
bull Derivatives
9
2Corporate securities
Shares
The total capital of a company may be divided into small units called shares For
example if the required capital of a company is US $500000 and is divided into 50000
units of US $10 each each unit is called a share of face value US $10 A share may be of
any face value depending upon the capital required and the number of shares into which
it is divided The holders of the shares are called share holders The shares can be
purchased or sold only in integral multiples
Equity shares signify ownership in a corporation and represent claim over the financial
assets and earnings of the corporation Shareholders enjoy voting rights and the right to
receive dividends however in case of liquidation they will receive residuals after all the
creditors of the company are settled in full A company may invite investors to subscribe
for the shares by the way of
bull Public issue through prospectus
bull Tender book building process
bull Offer for sale
bull Placement method
bull Rights issue
Stocks
The word stock refers to the old English law tradition where a share in the capital of the
company was not divided into ldquosharesrdquo of fixed denomination but was issued as one
chunk This concept is no more prevalent but the word ldquostockrdquo continues The word
ldquojoint stock companiesrdquo also refers to this tradition
10
Debt Instruments
A contractual arrangement in which the issuer agrees to pay interest and repay the
borrowed amount after a specified period of time is a debt instrument Certain features
common to all debt instruments are
bull Maturity ndash the number of years over which the issuer agrees to meet the
contractual obligations is the term to maturity Debt instruments are classified on
the basis of the time remaining to maturity
bull Par value ndash the face value or principal value of the debt instrument is called the
par value
bull Coupon rate ndash agreed rate of interest that is paid periodically to the investor and is
calculated as a percentage of the face value Some of the debt instruments may
not have an explicit coupon rate for instance zero coupon bonds These bonds are
issued on discount and redeemed at par Thus the difference between the
investorrsquos investment and return is the interest earned Coupon rates may be fixed
for the term or may be variable
bull Call option ndash option available to the issuer specified in the trust indenture to lsquocall
inrsquo the bonds and repay them at pre determined price before maturity Call feature
acts like a ceiling f or payments The issuer may call the bonds before the stated
maturity as it may recognize that the interest rates may fall below the coupon rate
and redeeming the bonds and replacing them with securities of lower coupon rates
will be economically beneficial It is the same as the prepayment option where
the borrower prepays before scheduled payments or slated maturity
o Some bonds are issued with lsquocall protection feature ie they would not be
11
called for a specified period of time
o Similar to the call option of the issuer there is a put option for the investor
to sell the securities back to the issuer at a predetermined price and date
The investor may do so anticipating rise in the interest rates wherein the
investor would liquidate the funds and alternatively invest in place of
higher interest
bull Refunding provisions ndash in case where the issuer may not have cash to redeem the
debt instruments the issuer may issue new debt instrument and use the proceeds to
repay the securities or to exercise the call option
Debt instruments may be of various kinds depending on the repayment
bull Bullet payment ndash instruments where the issuer agrees to repay the entire amount
at the maturity date ie lumpsum payment is called bullet payment
bull Sinking fund payment ndash instruments where the issuer agrees to retire a specified
portion of the debt each year is called sinking fund requirement
bull Amortization ndash instruments where there are scheduled principal repayments
before maturity date are called amortizing instruments
Debentures Bonds
The term Debenture is derived from the Latin word lsquodeberersquo which means lsquoto owe a
debtrsquo A debenture is an acknowledgment of debt taken either from the public or a
particular source A debenture may be viewed as a loan represented as marketable
security The word ldquobondrdquo may be used interchangeably with debentures
Debt instruments with maturity more than 5 years are called lsquobondsrsquo
Yields
Most common method of calculating the yields on debt instrument is the lsquoyield to
maturityrsquo method the formula is as under
12
Main differences between shares and debentures
bull Share money forms a part of the capital of the company The share holders are
part proprietors of the company whereas debentures are mere debt and debenture
holders are just creditors
bull Share holders get dividend only out of profits and in case of insufficient or no
profits they get nothing and debenture holders being creditors get guaranteed
interest as agreed whether the company makes profit or not
bull Share holders are paid after the debenture holders are paid their due first
bull The dividend on shares depends upon the profit of the company but the interest on
debentures is very well fixed at the time of issue itself
bull Shares are not to be paid back by the company whereas debentures have to be
paid back at the end of a fixed period
bull In case the company is wound up the share holders may lose a part or full of their
capital but he debenture holders invariably get back their investment
bull Investment in shares is riskier as it represents residual interest in the company
Debenture being debt is senior
bull Debentures are quite often secured that is a security interest is created on some
assets to back up debentures There is no question of any security in case of
shares
bull Share holders have a right to attend and vote at the meetings of the share holders
whereas debenture holders have no such rights
13
Quasi debt instruments
Preference shares
Preference shares are different from ordinary equity shares Preference share holders have
the following preferential rights
(i) The right to get a fixed rate of dividend before the payment of dividend to the equity
holders
(ii) The right to get back their capital before the equity holders in case of winding up of
the company
Eligibility norms for public issue ICDR Regulations
IPO
Conditions for IPO (all conditions listed below to be satisfied)
bull Net tangible assets of 3 crore in each of the preceding 3 full years of which not
more than 50 are held in monetary assets
bull Track record of distributable profits for 3 out of the immediately preceding 5
years
bull Net worth of 1 crore in each of the preceding three full years
bull Issue size of proposed issue + all previous issues made in the same financial year
does not exceed 5 times its pre-issue net worth as per the audited balance sheet of
the preceding financial year
bull In case of change of name within the last one year 50 of the revenue for the
preceding 1 full year earned by it from the activity indicated by the new name
14
If the issuer does not satisfy any of the condition listed above issuer may make IPO
by satisfying the following
1 Issue through book building
subject to allotment of 50 of net
offer to public to QIB failing
which full subscription monies to
be refunded
O
R
bull 15 of the cost of the project to
be contributed by SCB or PFI of
which not less than 10 from
the appraisers +
bull allotment of 10 of the net
offer to public to QIB failing
which full subscription monies
to be refunded
2 Minimum post-issue face value
capital of the issuer is 10 crores
O
R
Issuer to provide market-making for 2
yrs from the date of listing of the
specified securities
15
bull Promotersrsquo contribution
o Cannot be less than 20 of the post issue capital
o Maximum not defined but in view of the required minimum public offer as
per Rule 19 (2) (b) of Securities Contracts Regulations promoters
contribution plus any firm allotments cannot exceed 90 or 75 of the issue
size as the case may be (see below)
bull Minimum Public offer By public offer is meant the securities being offered to
public by advertisement exclusive of promotersrsquo contribution and firm allotments
o Rule 19(2)(b) of the Securities Contracts (Regulations) Rules 1957 requires
that the minimum public offer should be 25 of total issued securities should
be offered to public through advertisement
o However a lower public offer of 10 is allowed if the following conditions
are satisfied
1048707 The minimum public offer is Rs 100 crores and the number of
securities being offered to public is at least 20 lakh securities
1048707 The offer is made through mandatory book-building route with
minimum allocation of 60 to QIBs
bull Firm allotment reservations Subject to the minimum public offer norms issuers
are free to make reservations on competitive basis (as defined hereinafter) andor firm
allotments (as defined hereinafter) to various categories of persons for the remaining
part of the issue size
Firm allotment This implies allotment on a firm basis in public issues by an issuing
company Specified Categories for Firm allotment in public issues can be made to the
following
1 Indian and Multilateral Development Financial Institutions
16
2 Indian Mutual Funds
3 Foreign Institutional Investors (including non resident Indians and overseas
corporate bodies)
4 Permanent regular employees of the issuer company ndash maximum 10 of total
proposed issue amount
5 Scheduled Banks
6 Lead Merchant Banker- subject to a ceiling of 5 of the proposed issue
FPO
bull Promotersrsquo contribution
o In case of FPO the promoters should ensure participation either to the extent
of 20 of the proposed issue or their post-issue share holding must be to the
extent of 20 of the post issue capital Requirement to bring in contribution
from promoters shall be optional for a company listed on a stock exchange for
at least 3 years and having a track record of dividend payment of 3 years
immediately preceding the year of issue
o As for maximum promotersrsquo contribution Rule 19 (2) (b) stated above shall
be applicable
o Participation by promoters in excess of above shall be treated as preferential
allotment to which preferential allotment rules will be applicable As for
preferential allotment rules see Notes under sec 81
bull Net Public offer
o The minimum net public offer shall be as per Rule 19 (2) (b) ndash see above
17
bull Firm allotment reservations
o The issuer companies are free to make reservations on competitive basis (as
defined above) andor firm allotments to various categories of persons
enumerated above for the remaining issue size that is after considering
promotersrsquo contribution and public offer
o The reservation on competitive basis may also be made for retail individual
shareholders (RIS) For meaning of the term RIS see under lsquocategories of
investorsrsquo below
Composite Issue
bull Promotersrsquo contribution
o promoters have option to contribute either 20 of the proposed issue or 20
of post issue capital
o the right issue component to be excluded while computing the post-issue
capital
bull Others
o The right issue component to be offered to the existing shareholders
o Except the above the rules of allotment under IPO as above shall apply
Qualified Institutional Placement
Another class of issue not being a rights issue which calls for resolution under sec 81
(1A)
Condition for issue-
bull The equity shares of the same class were listed on a stock exchange having
nation-wide trading terminals for a period of at least one year as on the date of
issuance of notice for issue of shares to QIBs
bull The issue should not violate the prescribed minimum public shareholding
18
requirements specified by the listing agreement
Reservation
bull Minimum of 10 percent of specified securities issued shall be allotted to mutual
funds
bull In case the mutual funds do not agree to take shares issued under this chapter
such shares may be allotted to other QIBs
bull However no allotment shall be made under this chapter either directly or
indirectly to any QIB being a promoter or any person related to promoters
Withdrawal of bid not permitted- Investors shall not be allowed to withdraw their bids
after the closure of issue
Number of allottees-
bull minimum number of allottees shall not be less than
o Two where the issue size is less than or equal to Rs 250 crores
o Five where the issue size is greater than Rs 250 crores
bull No single allottee shall be allotted more than 50 of the issue size
Restrictions-
bull Amount raised through the proposed placement + all previous placements made in
the same financial year shall not exceed five times the net worth of the issuer as
per the audited balance sheet of the previous financial year
bull Lock-in-period of one year from the date of allotment except when sold on a
recognised stock exchange
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
2
PROJECT REPORT ON
CAPITAL MARKET PRODUCT
IN PARTIAL FULFILMENT OF
THE DEGREE AWARDED AT
BCOM (FINANCIAL MARKET)
SEMESTER-V
SUBMITTED TO
UNIVERSITY OF MUMBAI
FOR THE ACADEMIC YEAR 2015-2016
SUBMITTED BY
NAME TEJAS PAWASKAR
ROLL30
VIVA COLLEGE OF ARTS COMMERCE AND SCIENCE
VIRAR (WEST)
401303
3
DECLARATION
I hereby declare that the project CAPTIAL MARKET PRODUCT is an original work
prepared by me and is being submitted to UNIVERSITY OF MUMBAI in partial fulfillment of
the degree awarded at BCOM(FINANCAIL MARKET) for the academic year 2015-2016
To the best of my knowledge this report is not been submitted earlier to the university of
Mumbai or any other affiliated college for the fulfillment of BCom (FINANCIAL MARKETS)
degree
Date Name TEJAS PAWASKAR
Place Signature
4
ACKNOWLEDGEMENT
1TEJAS PAWASKAR the student of VIVA collage persuing my degree at
BCOM(FINANCIAL MARKET) would like to pay the credit for all those who helped me in
making project
The first in accomplishment of this project is our Principal DR R D Bhagat Vice Principal
Prof Prajakta Paranjape and project guide Prof RAKHEE OZA and course co-coordinator
Prof VASANTHI R Shenoy
I would like to thank of my friend teacher non-teaching staff who influence directly and
indirectly in making this project to me
5
INDEX
SR
NO
TOPIC PAGE
NO
1 CAPTIAL MARKET PRODUCT 6
2 CO-OPERATE SECURITIES 9
3 DERIVATIVES 20
4 FUTUREFORWARDAND OPTION 24
5 COMMODITY DERIVATIVES 32
6 BONDS 35
7 SHARES 38
8 COLLECTIVE INVESTMENTS SCHEME 40
9 DEBENTURE 43
10 SECURTY IN DIFFERENT JURISDICTIONS 44
11 CONCLUSION 45
12 BIBLIOGRAPHY 46
6
1CAPITAL MARKET PRODUCT
What are financial markets
Financial market is a market where financial instruments are exchanged or traded and
helps in determining the prices of the assets that are traded in and is also called the price
discovery process
1 Organizations that facilitate the trade in financial products For eg Stock exchanges
(NYSE Nasdaq) facilitate the trade in stocks bonds and warrants
2 Coming together of buyer and sellers at a common platform to trade financial products
is termed as financial markets ie stocks and shares are traded between buyers and
sellers in a number of ways including the use of stock exchanges directly between
buyers and sellers etc
Financial markets may be classified on the basis of
bull types of claims ndash debt and equity markets
bull maturity ndash money market and capital market
bull trade ndash spot market and delivery market
bull deals in financial claims ndash primary market and secondary market
Indian Financial Market consists of the following markets
bull Capital Market Securities Market
o Primary capital market
o Secondary capital market
bull Money Market
bull Debt Market
7
Capital market and money market
Financial markets can broadly be divided into money and capital market
Money Market Money market is a market for debt securities that pay off in the short term
usually less than one year for example the market for 90-days treasury bills This market
encompasses the trading and issuance of short term non equity debt instruments including
treasury bills commercial papers bankers acceptance certificates of deposits etc
Capital Market Capital market is a market for long-term debt and equity shares In this
market the capital funds comprising of both equity and debt are issued and traded This
also includes private placement sources of debt and equity as well as organized markets
like stock exchanges Capital market includes financial instruments with more than one
year maturity
Significance of Capital Markets
A well functioning stock market may help the development process in an economy
through the following channels
1 Growth of savings
2 Efficient allocation of investment resources
3 Better utilization of the existing resources
In market economy like India financial market institutions provide the avenue by which
long-term savings are mobilized and channeled into investments Confidence of the
investors in the market is imperative for the growth and development of the market For
any stock market the market Indices is the barometer of its performance and reflects the
prevailing sentiments of the entire economy Stock index is created to provide investors
with the information regarding the average share price in the stock market The ups and
8
downs in the index represent the movement of the equity market These indices need to
represent the return obtained by typical portfolios in the country
Generally the stock price of any company is vulnerable to three types of news
bull Company specific
bull Industry specific
bull Economy specific
An all share index includes stocks from all the sectors of the economy and thus cancels
out the stock and sector specific news and events that affect stock prices (law of portfolio
diversification) and reflect the overall performance of the companyequity market and the
news affecting it
The most important use of an equity market index is as a benchmark for a portfolio of
stocks All diversified portfolios belonging either to retail investors or mutual funds use
the common stock index as a yardstick for their returns Indices are useful in modern
financial application of derivatives
Capital Market Instruments ndash
some of the capital market instruments are
bull Equity
bull Preference shares
bull Debenture Bonds
bull ADRs GDRs
bull Derivatives
9
2Corporate securities
Shares
The total capital of a company may be divided into small units called shares For
example if the required capital of a company is US $500000 and is divided into 50000
units of US $10 each each unit is called a share of face value US $10 A share may be of
any face value depending upon the capital required and the number of shares into which
it is divided The holders of the shares are called share holders The shares can be
purchased or sold only in integral multiples
Equity shares signify ownership in a corporation and represent claim over the financial
assets and earnings of the corporation Shareholders enjoy voting rights and the right to
receive dividends however in case of liquidation they will receive residuals after all the
creditors of the company are settled in full A company may invite investors to subscribe
for the shares by the way of
bull Public issue through prospectus
bull Tender book building process
bull Offer for sale
bull Placement method
bull Rights issue
Stocks
The word stock refers to the old English law tradition where a share in the capital of the
company was not divided into ldquosharesrdquo of fixed denomination but was issued as one
chunk This concept is no more prevalent but the word ldquostockrdquo continues The word
ldquojoint stock companiesrdquo also refers to this tradition
10
Debt Instruments
A contractual arrangement in which the issuer agrees to pay interest and repay the
borrowed amount after a specified period of time is a debt instrument Certain features
common to all debt instruments are
bull Maturity ndash the number of years over which the issuer agrees to meet the
contractual obligations is the term to maturity Debt instruments are classified on
the basis of the time remaining to maturity
bull Par value ndash the face value or principal value of the debt instrument is called the
par value
bull Coupon rate ndash agreed rate of interest that is paid periodically to the investor and is
calculated as a percentage of the face value Some of the debt instruments may
not have an explicit coupon rate for instance zero coupon bonds These bonds are
issued on discount and redeemed at par Thus the difference between the
investorrsquos investment and return is the interest earned Coupon rates may be fixed
for the term or may be variable
bull Call option ndash option available to the issuer specified in the trust indenture to lsquocall
inrsquo the bonds and repay them at pre determined price before maturity Call feature
acts like a ceiling f or payments The issuer may call the bonds before the stated
maturity as it may recognize that the interest rates may fall below the coupon rate
and redeeming the bonds and replacing them with securities of lower coupon rates
will be economically beneficial It is the same as the prepayment option where
the borrower prepays before scheduled payments or slated maturity
o Some bonds are issued with lsquocall protection feature ie they would not be
11
called for a specified period of time
o Similar to the call option of the issuer there is a put option for the investor
to sell the securities back to the issuer at a predetermined price and date
The investor may do so anticipating rise in the interest rates wherein the
investor would liquidate the funds and alternatively invest in place of
higher interest
bull Refunding provisions ndash in case where the issuer may not have cash to redeem the
debt instruments the issuer may issue new debt instrument and use the proceeds to
repay the securities or to exercise the call option
Debt instruments may be of various kinds depending on the repayment
bull Bullet payment ndash instruments where the issuer agrees to repay the entire amount
at the maturity date ie lumpsum payment is called bullet payment
bull Sinking fund payment ndash instruments where the issuer agrees to retire a specified
portion of the debt each year is called sinking fund requirement
bull Amortization ndash instruments where there are scheduled principal repayments
before maturity date are called amortizing instruments
Debentures Bonds
The term Debenture is derived from the Latin word lsquodeberersquo which means lsquoto owe a
debtrsquo A debenture is an acknowledgment of debt taken either from the public or a
particular source A debenture may be viewed as a loan represented as marketable
security The word ldquobondrdquo may be used interchangeably with debentures
Debt instruments with maturity more than 5 years are called lsquobondsrsquo
Yields
Most common method of calculating the yields on debt instrument is the lsquoyield to
maturityrsquo method the formula is as under
12
Main differences between shares and debentures
bull Share money forms a part of the capital of the company The share holders are
part proprietors of the company whereas debentures are mere debt and debenture
holders are just creditors
bull Share holders get dividend only out of profits and in case of insufficient or no
profits they get nothing and debenture holders being creditors get guaranteed
interest as agreed whether the company makes profit or not
bull Share holders are paid after the debenture holders are paid their due first
bull The dividend on shares depends upon the profit of the company but the interest on
debentures is very well fixed at the time of issue itself
bull Shares are not to be paid back by the company whereas debentures have to be
paid back at the end of a fixed period
bull In case the company is wound up the share holders may lose a part or full of their
capital but he debenture holders invariably get back their investment
bull Investment in shares is riskier as it represents residual interest in the company
Debenture being debt is senior
bull Debentures are quite often secured that is a security interest is created on some
assets to back up debentures There is no question of any security in case of
shares
bull Share holders have a right to attend and vote at the meetings of the share holders
whereas debenture holders have no such rights
13
Quasi debt instruments
Preference shares
Preference shares are different from ordinary equity shares Preference share holders have
the following preferential rights
(i) The right to get a fixed rate of dividend before the payment of dividend to the equity
holders
(ii) The right to get back their capital before the equity holders in case of winding up of
the company
Eligibility norms for public issue ICDR Regulations
IPO
Conditions for IPO (all conditions listed below to be satisfied)
bull Net tangible assets of 3 crore in each of the preceding 3 full years of which not
more than 50 are held in monetary assets
bull Track record of distributable profits for 3 out of the immediately preceding 5
years
bull Net worth of 1 crore in each of the preceding three full years
bull Issue size of proposed issue + all previous issues made in the same financial year
does not exceed 5 times its pre-issue net worth as per the audited balance sheet of
the preceding financial year
bull In case of change of name within the last one year 50 of the revenue for the
preceding 1 full year earned by it from the activity indicated by the new name
14
If the issuer does not satisfy any of the condition listed above issuer may make IPO
by satisfying the following
1 Issue through book building
subject to allotment of 50 of net
offer to public to QIB failing
which full subscription monies to
be refunded
O
R
bull 15 of the cost of the project to
be contributed by SCB or PFI of
which not less than 10 from
the appraisers +
bull allotment of 10 of the net
offer to public to QIB failing
which full subscription monies
to be refunded
2 Minimum post-issue face value
capital of the issuer is 10 crores
O
R
Issuer to provide market-making for 2
yrs from the date of listing of the
specified securities
15
bull Promotersrsquo contribution
o Cannot be less than 20 of the post issue capital
o Maximum not defined but in view of the required minimum public offer as
per Rule 19 (2) (b) of Securities Contracts Regulations promoters
contribution plus any firm allotments cannot exceed 90 or 75 of the issue
size as the case may be (see below)
bull Minimum Public offer By public offer is meant the securities being offered to
public by advertisement exclusive of promotersrsquo contribution and firm allotments
o Rule 19(2)(b) of the Securities Contracts (Regulations) Rules 1957 requires
that the minimum public offer should be 25 of total issued securities should
be offered to public through advertisement
o However a lower public offer of 10 is allowed if the following conditions
are satisfied
1048707 The minimum public offer is Rs 100 crores and the number of
securities being offered to public is at least 20 lakh securities
1048707 The offer is made through mandatory book-building route with
minimum allocation of 60 to QIBs
bull Firm allotment reservations Subject to the minimum public offer norms issuers
are free to make reservations on competitive basis (as defined hereinafter) andor firm
allotments (as defined hereinafter) to various categories of persons for the remaining
part of the issue size
Firm allotment This implies allotment on a firm basis in public issues by an issuing
company Specified Categories for Firm allotment in public issues can be made to the
following
1 Indian and Multilateral Development Financial Institutions
16
2 Indian Mutual Funds
3 Foreign Institutional Investors (including non resident Indians and overseas
corporate bodies)
4 Permanent regular employees of the issuer company ndash maximum 10 of total
proposed issue amount
5 Scheduled Banks
6 Lead Merchant Banker- subject to a ceiling of 5 of the proposed issue
FPO
bull Promotersrsquo contribution
o In case of FPO the promoters should ensure participation either to the extent
of 20 of the proposed issue or their post-issue share holding must be to the
extent of 20 of the post issue capital Requirement to bring in contribution
from promoters shall be optional for a company listed on a stock exchange for
at least 3 years and having a track record of dividend payment of 3 years
immediately preceding the year of issue
o As for maximum promotersrsquo contribution Rule 19 (2) (b) stated above shall
be applicable
o Participation by promoters in excess of above shall be treated as preferential
allotment to which preferential allotment rules will be applicable As for
preferential allotment rules see Notes under sec 81
bull Net Public offer
o The minimum net public offer shall be as per Rule 19 (2) (b) ndash see above
17
bull Firm allotment reservations
o The issuer companies are free to make reservations on competitive basis (as
defined above) andor firm allotments to various categories of persons
enumerated above for the remaining issue size that is after considering
promotersrsquo contribution and public offer
o The reservation on competitive basis may also be made for retail individual
shareholders (RIS) For meaning of the term RIS see under lsquocategories of
investorsrsquo below
Composite Issue
bull Promotersrsquo contribution
o promoters have option to contribute either 20 of the proposed issue or 20
of post issue capital
o the right issue component to be excluded while computing the post-issue
capital
bull Others
o The right issue component to be offered to the existing shareholders
o Except the above the rules of allotment under IPO as above shall apply
Qualified Institutional Placement
Another class of issue not being a rights issue which calls for resolution under sec 81
(1A)
Condition for issue-
bull The equity shares of the same class were listed on a stock exchange having
nation-wide trading terminals for a period of at least one year as on the date of
issuance of notice for issue of shares to QIBs
bull The issue should not violate the prescribed minimum public shareholding
18
requirements specified by the listing agreement
Reservation
bull Minimum of 10 percent of specified securities issued shall be allotted to mutual
funds
bull In case the mutual funds do not agree to take shares issued under this chapter
such shares may be allotted to other QIBs
bull However no allotment shall be made under this chapter either directly or
indirectly to any QIB being a promoter or any person related to promoters
Withdrawal of bid not permitted- Investors shall not be allowed to withdraw their bids
after the closure of issue
Number of allottees-
bull minimum number of allottees shall not be less than
o Two where the issue size is less than or equal to Rs 250 crores
o Five where the issue size is greater than Rs 250 crores
bull No single allottee shall be allotted more than 50 of the issue size
Restrictions-
bull Amount raised through the proposed placement + all previous placements made in
the same financial year shall not exceed five times the net worth of the issuer as
per the audited balance sheet of the previous financial year
bull Lock-in-period of one year from the date of allotment except when sold on a
recognised stock exchange
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
3
DECLARATION
I hereby declare that the project CAPTIAL MARKET PRODUCT is an original work
prepared by me and is being submitted to UNIVERSITY OF MUMBAI in partial fulfillment of
the degree awarded at BCOM(FINANCAIL MARKET) for the academic year 2015-2016
To the best of my knowledge this report is not been submitted earlier to the university of
Mumbai or any other affiliated college for the fulfillment of BCom (FINANCIAL MARKETS)
degree
Date Name TEJAS PAWASKAR
Place Signature
4
ACKNOWLEDGEMENT
1TEJAS PAWASKAR the student of VIVA collage persuing my degree at
BCOM(FINANCIAL MARKET) would like to pay the credit for all those who helped me in
making project
The first in accomplishment of this project is our Principal DR R D Bhagat Vice Principal
Prof Prajakta Paranjape and project guide Prof RAKHEE OZA and course co-coordinator
Prof VASANTHI R Shenoy
I would like to thank of my friend teacher non-teaching staff who influence directly and
indirectly in making this project to me
5
INDEX
SR
NO
TOPIC PAGE
NO
1 CAPTIAL MARKET PRODUCT 6
2 CO-OPERATE SECURITIES 9
3 DERIVATIVES 20
4 FUTUREFORWARDAND OPTION 24
5 COMMODITY DERIVATIVES 32
6 BONDS 35
7 SHARES 38
8 COLLECTIVE INVESTMENTS SCHEME 40
9 DEBENTURE 43
10 SECURTY IN DIFFERENT JURISDICTIONS 44
11 CONCLUSION 45
12 BIBLIOGRAPHY 46
6
1CAPITAL MARKET PRODUCT
What are financial markets
Financial market is a market where financial instruments are exchanged or traded and
helps in determining the prices of the assets that are traded in and is also called the price
discovery process
1 Organizations that facilitate the trade in financial products For eg Stock exchanges
(NYSE Nasdaq) facilitate the trade in stocks bonds and warrants
2 Coming together of buyer and sellers at a common platform to trade financial products
is termed as financial markets ie stocks and shares are traded between buyers and
sellers in a number of ways including the use of stock exchanges directly between
buyers and sellers etc
Financial markets may be classified on the basis of
bull types of claims ndash debt and equity markets
bull maturity ndash money market and capital market
bull trade ndash spot market and delivery market
bull deals in financial claims ndash primary market and secondary market
Indian Financial Market consists of the following markets
bull Capital Market Securities Market
o Primary capital market
o Secondary capital market
bull Money Market
bull Debt Market
7
Capital market and money market
Financial markets can broadly be divided into money and capital market
Money Market Money market is a market for debt securities that pay off in the short term
usually less than one year for example the market for 90-days treasury bills This market
encompasses the trading and issuance of short term non equity debt instruments including
treasury bills commercial papers bankers acceptance certificates of deposits etc
Capital Market Capital market is a market for long-term debt and equity shares In this
market the capital funds comprising of both equity and debt are issued and traded This
also includes private placement sources of debt and equity as well as organized markets
like stock exchanges Capital market includes financial instruments with more than one
year maturity
Significance of Capital Markets
A well functioning stock market may help the development process in an economy
through the following channels
1 Growth of savings
2 Efficient allocation of investment resources
3 Better utilization of the existing resources
In market economy like India financial market institutions provide the avenue by which
long-term savings are mobilized and channeled into investments Confidence of the
investors in the market is imperative for the growth and development of the market For
any stock market the market Indices is the barometer of its performance and reflects the
prevailing sentiments of the entire economy Stock index is created to provide investors
with the information regarding the average share price in the stock market The ups and
8
downs in the index represent the movement of the equity market These indices need to
represent the return obtained by typical portfolios in the country
Generally the stock price of any company is vulnerable to three types of news
bull Company specific
bull Industry specific
bull Economy specific
An all share index includes stocks from all the sectors of the economy and thus cancels
out the stock and sector specific news and events that affect stock prices (law of portfolio
diversification) and reflect the overall performance of the companyequity market and the
news affecting it
The most important use of an equity market index is as a benchmark for a portfolio of
stocks All diversified portfolios belonging either to retail investors or mutual funds use
the common stock index as a yardstick for their returns Indices are useful in modern
financial application of derivatives
Capital Market Instruments ndash
some of the capital market instruments are
bull Equity
bull Preference shares
bull Debenture Bonds
bull ADRs GDRs
bull Derivatives
9
2Corporate securities
Shares
The total capital of a company may be divided into small units called shares For
example if the required capital of a company is US $500000 and is divided into 50000
units of US $10 each each unit is called a share of face value US $10 A share may be of
any face value depending upon the capital required and the number of shares into which
it is divided The holders of the shares are called share holders The shares can be
purchased or sold only in integral multiples
Equity shares signify ownership in a corporation and represent claim over the financial
assets and earnings of the corporation Shareholders enjoy voting rights and the right to
receive dividends however in case of liquidation they will receive residuals after all the
creditors of the company are settled in full A company may invite investors to subscribe
for the shares by the way of
bull Public issue through prospectus
bull Tender book building process
bull Offer for sale
bull Placement method
bull Rights issue
Stocks
The word stock refers to the old English law tradition where a share in the capital of the
company was not divided into ldquosharesrdquo of fixed denomination but was issued as one
chunk This concept is no more prevalent but the word ldquostockrdquo continues The word
ldquojoint stock companiesrdquo also refers to this tradition
10
Debt Instruments
A contractual arrangement in which the issuer agrees to pay interest and repay the
borrowed amount after a specified period of time is a debt instrument Certain features
common to all debt instruments are
bull Maturity ndash the number of years over which the issuer agrees to meet the
contractual obligations is the term to maturity Debt instruments are classified on
the basis of the time remaining to maturity
bull Par value ndash the face value or principal value of the debt instrument is called the
par value
bull Coupon rate ndash agreed rate of interest that is paid periodically to the investor and is
calculated as a percentage of the face value Some of the debt instruments may
not have an explicit coupon rate for instance zero coupon bonds These bonds are
issued on discount and redeemed at par Thus the difference between the
investorrsquos investment and return is the interest earned Coupon rates may be fixed
for the term or may be variable
bull Call option ndash option available to the issuer specified in the trust indenture to lsquocall
inrsquo the bonds and repay them at pre determined price before maturity Call feature
acts like a ceiling f or payments The issuer may call the bonds before the stated
maturity as it may recognize that the interest rates may fall below the coupon rate
and redeeming the bonds and replacing them with securities of lower coupon rates
will be economically beneficial It is the same as the prepayment option where
the borrower prepays before scheduled payments or slated maturity
o Some bonds are issued with lsquocall protection feature ie they would not be
11
called for a specified period of time
o Similar to the call option of the issuer there is a put option for the investor
to sell the securities back to the issuer at a predetermined price and date
The investor may do so anticipating rise in the interest rates wherein the
investor would liquidate the funds and alternatively invest in place of
higher interest
bull Refunding provisions ndash in case where the issuer may not have cash to redeem the
debt instruments the issuer may issue new debt instrument and use the proceeds to
repay the securities or to exercise the call option
Debt instruments may be of various kinds depending on the repayment
bull Bullet payment ndash instruments where the issuer agrees to repay the entire amount
at the maturity date ie lumpsum payment is called bullet payment
bull Sinking fund payment ndash instruments where the issuer agrees to retire a specified
portion of the debt each year is called sinking fund requirement
bull Amortization ndash instruments where there are scheduled principal repayments
before maturity date are called amortizing instruments
Debentures Bonds
The term Debenture is derived from the Latin word lsquodeberersquo which means lsquoto owe a
debtrsquo A debenture is an acknowledgment of debt taken either from the public or a
particular source A debenture may be viewed as a loan represented as marketable
security The word ldquobondrdquo may be used interchangeably with debentures
Debt instruments with maturity more than 5 years are called lsquobondsrsquo
Yields
Most common method of calculating the yields on debt instrument is the lsquoyield to
maturityrsquo method the formula is as under
12
Main differences between shares and debentures
bull Share money forms a part of the capital of the company The share holders are
part proprietors of the company whereas debentures are mere debt and debenture
holders are just creditors
bull Share holders get dividend only out of profits and in case of insufficient or no
profits they get nothing and debenture holders being creditors get guaranteed
interest as agreed whether the company makes profit or not
bull Share holders are paid after the debenture holders are paid their due first
bull The dividend on shares depends upon the profit of the company but the interest on
debentures is very well fixed at the time of issue itself
bull Shares are not to be paid back by the company whereas debentures have to be
paid back at the end of a fixed period
bull In case the company is wound up the share holders may lose a part or full of their
capital but he debenture holders invariably get back their investment
bull Investment in shares is riskier as it represents residual interest in the company
Debenture being debt is senior
bull Debentures are quite often secured that is a security interest is created on some
assets to back up debentures There is no question of any security in case of
shares
bull Share holders have a right to attend and vote at the meetings of the share holders
whereas debenture holders have no such rights
13
Quasi debt instruments
Preference shares
Preference shares are different from ordinary equity shares Preference share holders have
the following preferential rights
(i) The right to get a fixed rate of dividend before the payment of dividend to the equity
holders
(ii) The right to get back their capital before the equity holders in case of winding up of
the company
Eligibility norms for public issue ICDR Regulations
IPO
Conditions for IPO (all conditions listed below to be satisfied)
bull Net tangible assets of 3 crore in each of the preceding 3 full years of which not
more than 50 are held in monetary assets
bull Track record of distributable profits for 3 out of the immediately preceding 5
years
bull Net worth of 1 crore in each of the preceding three full years
bull Issue size of proposed issue + all previous issues made in the same financial year
does not exceed 5 times its pre-issue net worth as per the audited balance sheet of
the preceding financial year
bull In case of change of name within the last one year 50 of the revenue for the
preceding 1 full year earned by it from the activity indicated by the new name
14
If the issuer does not satisfy any of the condition listed above issuer may make IPO
by satisfying the following
1 Issue through book building
subject to allotment of 50 of net
offer to public to QIB failing
which full subscription monies to
be refunded
O
R
bull 15 of the cost of the project to
be contributed by SCB or PFI of
which not less than 10 from
the appraisers +
bull allotment of 10 of the net
offer to public to QIB failing
which full subscription monies
to be refunded
2 Minimum post-issue face value
capital of the issuer is 10 crores
O
R
Issuer to provide market-making for 2
yrs from the date of listing of the
specified securities
15
bull Promotersrsquo contribution
o Cannot be less than 20 of the post issue capital
o Maximum not defined but in view of the required minimum public offer as
per Rule 19 (2) (b) of Securities Contracts Regulations promoters
contribution plus any firm allotments cannot exceed 90 or 75 of the issue
size as the case may be (see below)
bull Minimum Public offer By public offer is meant the securities being offered to
public by advertisement exclusive of promotersrsquo contribution and firm allotments
o Rule 19(2)(b) of the Securities Contracts (Regulations) Rules 1957 requires
that the minimum public offer should be 25 of total issued securities should
be offered to public through advertisement
o However a lower public offer of 10 is allowed if the following conditions
are satisfied
1048707 The minimum public offer is Rs 100 crores and the number of
securities being offered to public is at least 20 lakh securities
1048707 The offer is made through mandatory book-building route with
minimum allocation of 60 to QIBs
bull Firm allotment reservations Subject to the minimum public offer norms issuers
are free to make reservations on competitive basis (as defined hereinafter) andor firm
allotments (as defined hereinafter) to various categories of persons for the remaining
part of the issue size
Firm allotment This implies allotment on a firm basis in public issues by an issuing
company Specified Categories for Firm allotment in public issues can be made to the
following
1 Indian and Multilateral Development Financial Institutions
16
2 Indian Mutual Funds
3 Foreign Institutional Investors (including non resident Indians and overseas
corporate bodies)
4 Permanent regular employees of the issuer company ndash maximum 10 of total
proposed issue amount
5 Scheduled Banks
6 Lead Merchant Banker- subject to a ceiling of 5 of the proposed issue
FPO
bull Promotersrsquo contribution
o In case of FPO the promoters should ensure participation either to the extent
of 20 of the proposed issue or their post-issue share holding must be to the
extent of 20 of the post issue capital Requirement to bring in contribution
from promoters shall be optional for a company listed on a stock exchange for
at least 3 years and having a track record of dividend payment of 3 years
immediately preceding the year of issue
o As for maximum promotersrsquo contribution Rule 19 (2) (b) stated above shall
be applicable
o Participation by promoters in excess of above shall be treated as preferential
allotment to which preferential allotment rules will be applicable As for
preferential allotment rules see Notes under sec 81
bull Net Public offer
o The minimum net public offer shall be as per Rule 19 (2) (b) ndash see above
17
bull Firm allotment reservations
o The issuer companies are free to make reservations on competitive basis (as
defined above) andor firm allotments to various categories of persons
enumerated above for the remaining issue size that is after considering
promotersrsquo contribution and public offer
o The reservation on competitive basis may also be made for retail individual
shareholders (RIS) For meaning of the term RIS see under lsquocategories of
investorsrsquo below
Composite Issue
bull Promotersrsquo contribution
o promoters have option to contribute either 20 of the proposed issue or 20
of post issue capital
o the right issue component to be excluded while computing the post-issue
capital
bull Others
o The right issue component to be offered to the existing shareholders
o Except the above the rules of allotment under IPO as above shall apply
Qualified Institutional Placement
Another class of issue not being a rights issue which calls for resolution under sec 81
(1A)
Condition for issue-
bull The equity shares of the same class were listed on a stock exchange having
nation-wide trading terminals for a period of at least one year as on the date of
issuance of notice for issue of shares to QIBs
bull The issue should not violate the prescribed minimum public shareholding
18
requirements specified by the listing agreement
Reservation
bull Minimum of 10 percent of specified securities issued shall be allotted to mutual
funds
bull In case the mutual funds do not agree to take shares issued under this chapter
such shares may be allotted to other QIBs
bull However no allotment shall be made under this chapter either directly or
indirectly to any QIB being a promoter or any person related to promoters
Withdrawal of bid not permitted- Investors shall not be allowed to withdraw their bids
after the closure of issue
Number of allottees-
bull minimum number of allottees shall not be less than
o Two where the issue size is less than or equal to Rs 250 crores
o Five where the issue size is greater than Rs 250 crores
bull No single allottee shall be allotted more than 50 of the issue size
Restrictions-
bull Amount raised through the proposed placement + all previous placements made in
the same financial year shall not exceed five times the net worth of the issuer as
per the audited balance sheet of the previous financial year
bull Lock-in-period of one year from the date of allotment except when sold on a
recognised stock exchange
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
4
ACKNOWLEDGEMENT
1TEJAS PAWASKAR the student of VIVA collage persuing my degree at
BCOM(FINANCIAL MARKET) would like to pay the credit for all those who helped me in
making project
The first in accomplishment of this project is our Principal DR R D Bhagat Vice Principal
Prof Prajakta Paranjape and project guide Prof RAKHEE OZA and course co-coordinator
Prof VASANTHI R Shenoy
I would like to thank of my friend teacher non-teaching staff who influence directly and
indirectly in making this project to me
5
INDEX
SR
NO
TOPIC PAGE
NO
1 CAPTIAL MARKET PRODUCT 6
2 CO-OPERATE SECURITIES 9
3 DERIVATIVES 20
4 FUTUREFORWARDAND OPTION 24
5 COMMODITY DERIVATIVES 32
6 BONDS 35
7 SHARES 38
8 COLLECTIVE INVESTMENTS SCHEME 40
9 DEBENTURE 43
10 SECURTY IN DIFFERENT JURISDICTIONS 44
11 CONCLUSION 45
12 BIBLIOGRAPHY 46
6
1CAPITAL MARKET PRODUCT
What are financial markets
Financial market is a market where financial instruments are exchanged or traded and
helps in determining the prices of the assets that are traded in and is also called the price
discovery process
1 Organizations that facilitate the trade in financial products For eg Stock exchanges
(NYSE Nasdaq) facilitate the trade in stocks bonds and warrants
2 Coming together of buyer and sellers at a common platform to trade financial products
is termed as financial markets ie stocks and shares are traded between buyers and
sellers in a number of ways including the use of stock exchanges directly between
buyers and sellers etc
Financial markets may be classified on the basis of
bull types of claims ndash debt and equity markets
bull maturity ndash money market and capital market
bull trade ndash spot market and delivery market
bull deals in financial claims ndash primary market and secondary market
Indian Financial Market consists of the following markets
bull Capital Market Securities Market
o Primary capital market
o Secondary capital market
bull Money Market
bull Debt Market
7
Capital market and money market
Financial markets can broadly be divided into money and capital market
Money Market Money market is a market for debt securities that pay off in the short term
usually less than one year for example the market for 90-days treasury bills This market
encompasses the trading and issuance of short term non equity debt instruments including
treasury bills commercial papers bankers acceptance certificates of deposits etc
Capital Market Capital market is a market for long-term debt and equity shares In this
market the capital funds comprising of both equity and debt are issued and traded This
also includes private placement sources of debt and equity as well as organized markets
like stock exchanges Capital market includes financial instruments with more than one
year maturity
Significance of Capital Markets
A well functioning stock market may help the development process in an economy
through the following channels
1 Growth of savings
2 Efficient allocation of investment resources
3 Better utilization of the existing resources
In market economy like India financial market institutions provide the avenue by which
long-term savings are mobilized and channeled into investments Confidence of the
investors in the market is imperative for the growth and development of the market For
any stock market the market Indices is the barometer of its performance and reflects the
prevailing sentiments of the entire economy Stock index is created to provide investors
with the information regarding the average share price in the stock market The ups and
8
downs in the index represent the movement of the equity market These indices need to
represent the return obtained by typical portfolios in the country
Generally the stock price of any company is vulnerable to three types of news
bull Company specific
bull Industry specific
bull Economy specific
An all share index includes stocks from all the sectors of the economy and thus cancels
out the stock and sector specific news and events that affect stock prices (law of portfolio
diversification) and reflect the overall performance of the companyequity market and the
news affecting it
The most important use of an equity market index is as a benchmark for a portfolio of
stocks All diversified portfolios belonging either to retail investors or mutual funds use
the common stock index as a yardstick for their returns Indices are useful in modern
financial application of derivatives
Capital Market Instruments ndash
some of the capital market instruments are
bull Equity
bull Preference shares
bull Debenture Bonds
bull ADRs GDRs
bull Derivatives
9
2Corporate securities
Shares
The total capital of a company may be divided into small units called shares For
example if the required capital of a company is US $500000 and is divided into 50000
units of US $10 each each unit is called a share of face value US $10 A share may be of
any face value depending upon the capital required and the number of shares into which
it is divided The holders of the shares are called share holders The shares can be
purchased or sold only in integral multiples
Equity shares signify ownership in a corporation and represent claim over the financial
assets and earnings of the corporation Shareholders enjoy voting rights and the right to
receive dividends however in case of liquidation they will receive residuals after all the
creditors of the company are settled in full A company may invite investors to subscribe
for the shares by the way of
bull Public issue through prospectus
bull Tender book building process
bull Offer for sale
bull Placement method
bull Rights issue
Stocks
The word stock refers to the old English law tradition where a share in the capital of the
company was not divided into ldquosharesrdquo of fixed denomination but was issued as one
chunk This concept is no more prevalent but the word ldquostockrdquo continues The word
ldquojoint stock companiesrdquo also refers to this tradition
10
Debt Instruments
A contractual arrangement in which the issuer agrees to pay interest and repay the
borrowed amount after a specified period of time is a debt instrument Certain features
common to all debt instruments are
bull Maturity ndash the number of years over which the issuer agrees to meet the
contractual obligations is the term to maturity Debt instruments are classified on
the basis of the time remaining to maturity
bull Par value ndash the face value or principal value of the debt instrument is called the
par value
bull Coupon rate ndash agreed rate of interest that is paid periodically to the investor and is
calculated as a percentage of the face value Some of the debt instruments may
not have an explicit coupon rate for instance zero coupon bonds These bonds are
issued on discount and redeemed at par Thus the difference between the
investorrsquos investment and return is the interest earned Coupon rates may be fixed
for the term or may be variable
bull Call option ndash option available to the issuer specified in the trust indenture to lsquocall
inrsquo the bonds and repay them at pre determined price before maturity Call feature
acts like a ceiling f or payments The issuer may call the bonds before the stated
maturity as it may recognize that the interest rates may fall below the coupon rate
and redeeming the bonds and replacing them with securities of lower coupon rates
will be economically beneficial It is the same as the prepayment option where
the borrower prepays before scheduled payments or slated maturity
o Some bonds are issued with lsquocall protection feature ie they would not be
11
called for a specified period of time
o Similar to the call option of the issuer there is a put option for the investor
to sell the securities back to the issuer at a predetermined price and date
The investor may do so anticipating rise in the interest rates wherein the
investor would liquidate the funds and alternatively invest in place of
higher interest
bull Refunding provisions ndash in case where the issuer may not have cash to redeem the
debt instruments the issuer may issue new debt instrument and use the proceeds to
repay the securities or to exercise the call option
Debt instruments may be of various kinds depending on the repayment
bull Bullet payment ndash instruments where the issuer agrees to repay the entire amount
at the maturity date ie lumpsum payment is called bullet payment
bull Sinking fund payment ndash instruments where the issuer agrees to retire a specified
portion of the debt each year is called sinking fund requirement
bull Amortization ndash instruments where there are scheduled principal repayments
before maturity date are called amortizing instruments
Debentures Bonds
The term Debenture is derived from the Latin word lsquodeberersquo which means lsquoto owe a
debtrsquo A debenture is an acknowledgment of debt taken either from the public or a
particular source A debenture may be viewed as a loan represented as marketable
security The word ldquobondrdquo may be used interchangeably with debentures
Debt instruments with maturity more than 5 years are called lsquobondsrsquo
Yields
Most common method of calculating the yields on debt instrument is the lsquoyield to
maturityrsquo method the formula is as under
12
Main differences between shares and debentures
bull Share money forms a part of the capital of the company The share holders are
part proprietors of the company whereas debentures are mere debt and debenture
holders are just creditors
bull Share holders get dividend only out of profits and in case of insufficient or no
profits they get nothing and debenture holders being creditors get guaranteed
interest as agreed whether the company makes profit or not
bull Share holders are paid after the debenture holders are paid their due first
bull The dividend on shares depends upon the profit of the company but the interest on
debentures is very well fixed at the time of issue itself
bull Shares are not to be paid back by the company whereas debentures have to be
paid back at the end of a fixed period
bull In case the company is wound up the share holders may lose a part or full of their
capital but he debenture holders invariably get back their investment
bull Investment in shares is riskier as it represents residual interest in the company
Debenture being debt is senior
bull Debentures are quite often secured that is a security interest is created on some
assets to back up debentures There is no question of any security in case of
shares
bull Share holders have a right to attend and vote at the meetings of the share holders
whereas debenture holders have no such rights
13
Quasi debt instruments
Preference shares
Preference shares are different from ordinary equity shares Preference share holders have
the following preferential rights
(i) The right to get a fixed rate of dividend before the payment of dividend to the equity
holders
(ii) The right to get back their capital before the equity holders in case of winding up of
the company
Eligibility norms for public issue ICDR Regulations
IPO
Conditions for IPO (all conditions listed below to be satisfied)
bull Net tangible assets of 3 crore in each of the preceding 3 full years of which not
more than 50 are held in monetary assets
bull Track record of distributable profits for 3 out of the immediately preceding 5
years
bull Net worth of 1 crore in each of the preceding three full years
bull Issue size of proposed issue + all previous issues made in the same financial year
does not exceed 5 times its pre-issue net worth as per the audited balance sheet of
the preceding financial year
bull In case of change of name within the last one year 50 of the revenue for the
preceding 1 full year earned by it from the activity indicated by the new name
14
If the issuer does not satisfy any of the condition listed above issuer may make IPO
by satisfying the following
1 Issue through book building
subject to allotment of 50 of net
offer to public to QIB failing
which full subscription monies to
be refunded
O
R
bull 15 of the cost of the project to
be contributed by SCB or PFI of
which not less than 10 from
the appraisers +
bull allotment of 10 of the net
offer to public to QIB failing
which full subscription monies
to be refunded
2 Minimum post-issue face value
capital of the issuer is 10 crores
O
R
Issuer to provide market-making for 2
yrs from the date of listing of the
specified securities
15
bull Promotersrsquo contribution
o Cannot be less than 20 of the post issue capital
o Maximum not defined but in view of the required minimum public offer as
per Rule 19 (2) (b) of Securities Contracts Regulations promoters
contribution plus any firm allotments cannot exceed 90 or 75 of the issue
size as the case may be (see below)
bull Minimum Public offer By public offer is meant the securities being offered to
public by advertisement exclusive of promotersrsquo contribution and firm allotments
o Rule 19(2)(b) of the Securities Contracts (Regulations) Rules 1957 requires
that the minimum public offer should be 25 of total issued securities should
be offered to public through advertisement
o However a lower public offer of 10 is allowed if the following conditions
are satisfied
1048707 The minimum public offer is Rs 100 crores and the number of
securities being offered to public is at least 20 lakh securities
1048707 The offer is made through mandatory book-building route with
minimum allocation of 60 to QIBs
bull Firm allotment reservations Subject to the minimum public offer norms issuers
are free to make reservations on competitive basis (as defined hereinafter) andor firm
allotments (as defined hereinafter) to various categories of persons for the remaining
part of the issue size
Firm allotment This implies allotment on a firm basis in public issues by an issuing
company Specified Categories for Firm allotment in public issues can be made to the
following
1 Indian and Multilateral Development Financial Institutions
16
2 Indian Mutual Funds
3 Foreign Institutional Investors (including non resident Indians and overseas
corporate bodies)
4 Permanent regular employees of the issuer company ndash maximum 10 of total
proposed issue amount
5 Scheduled Banks
6 Lead Merchant Banker- subject to a ceiling of 5 of the proposed issue
FPO
bull Promotersrsquo contribution
o In case of FPO the promoters should ensure participation either to the extent
of 20 of the proposed issue or their post-issue share holding must be to the
extent of 20 of the post issue capital Requirement to bring in contribution
from promoters shall be optional for a company listed on a stock exchange for
at least 3 years and having a track record of dividend payment of 3 years
immediately preceding the year of issue
o As for maximum promotersrsquo contribution Rule 19 (2) (b) stated above shall
be applicable
o Participation by promoters in excess of above shall be treated as preferential
allotment to which preferential allotment rules will be applicable As for
preferential allotment rules see Notes under sec 81
bull Net Public offer
o The minimum net public offer shall be as per Rule 19 (2) (b) ndash see above
17
bull Firm allotment reservations
o The issuer companies are free to make reservations on competitive basis (as
defined above) andor firm allotments to various categories of persons
enumerated above for the remaining issue size that is after considering
promotersrsquo contribution and public offer
o The reservation on competitive basis may also be made for retail individual
shareholders (RIS) For meaning of the term RIS see under lsquocategories of
investorsrsquo below
Composite Issue
bull Promotersrsquo contribution
o promoters have option to contribute either 20 of the proposed issue or 20
of post issue capital
o the right issue component to be excluded while computing the post-issue
capital
bull Others
o The right issue component to be offered to the existing shareholders
o Except the above the rules of allotment under IPO as above shall apply
Qualified Institutional Placement
Another class of issue not being a rights issue which calls for resolution under sec 81
(1A)
Condition for issue-
bull The equity shares of the same class were listed on a stock exchange having
nation-wide trading terminals for a period of at least one year as on the date of
issuance of notice for issue of shares to QIBs
bull The issue should not violate the prescribed minimum public shareholding
18
requirements specified by the listing agreement
Reservation
bull Minimum of 10 percent of specified securities issued shall be allotted to mutual
funds
bull In case the mutual funds do not agree to take shares issued under this chapter
such shares may be allotted to other QIBs
bull However no allotment shall be made under this chapter either directly or
indirectly to any QIB being a promoter or any person related to promoters
Withdrawal of bid not permitted- Investors shall not be allowed to withdraw their bids
after the closure of issue
Number of allottees-
bull minimum number of allottees shall not be less than
o Two where the issue size is less than or equal to Rs 250 crores
o Five where the issue size is greater than Rs 250 crores
bull No single allottee shall be allotted more than 50 of the issue size
Restrictions-
bull Amount raised through the proposed placement + all previous placements made in
the same financial year shall not exceed five times the net worth of the issuer as
per the audited balance sheet of the previous financial year
bull Lock-in-period of one year from the date of allotment except when sold on a
recognised stock exchange
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
5
INDEX
SR
NO
TOPIC PAGE
NO
1 CAPTIAL MARKET PRODUCT 6
2 CO-OPERATE SECURITIES 9
3 DERIVATIVES 20
4 FUTUREFORWARDAND OPTION 24
5 COMMODITY DERIVATIVES 32
6 BONDS 35
7 SHARES 38
8 COLLECTIVE INVESTMENTS SCHEME 40
9 DEBENTURE 43
10 SECURTY IN DIFFERENT JURISDICTIONS 44
11 CONCLUSION 45
12 BIBLIOGRAPHY 46
6
1CAPITAL MARKET PRODUCT
What are financial markets
Financial market is a market where financial instruments are exchanged or traded and
helps in determining the prices of the assets that are traded in and is also called the price
discovery process
1 Organizations that facilitate the trade in financial products For eg Stock exchanges
(NYSE Nasdaq) facilitate the trade in stocks bonds and warrants
2 Coming together of buyer and sellers at a common platform to trade financial products
is termed as financial markets ie stocks and shares are traded between buyers and
sellers in a number of ways including the use of stock exchanges directly between
buyers and sellers etc
Financial markets may be classified on the basis of
bull types of claims ndash debt and equity markets
bull maturity ndash money market and capital market
bull trade ndash spot market and delivery market
bull deals in financial claims ndash primary market and secondary market
Indian Financial Market consists of the following markets
bull Capital Market Securities Market
o Primary capital market
o Secondary capital market
bull Money Market
bull Debt Market
7
Capital market and money market
Financial markets can broadly be divided into money and capital market
Money Market Money market is a market for debt securities that pay off in the short term
usually less than one year for example the market for 90-days treasury bills This market
encompasses the trading and issuance of short term non equity debt instruments including
treasury bills commercial papers bankers acceptance certificates of deposits etc
Capital Market Capital market is a market for long-term debt and equity shares In this
market the capital funds comprising of both equity and debt are issued and traded This
also includes private placement sources of debt and equity as well as organized markets
like stock exchanges Capital market includes financial instruments with more than one
year maturity
Significance of Capital Markets
A well functioning stock market may help the development process in an economy
through the following channels
1 Growth of savings
2 Efficient allocation of investment resources
3 Better utilization of the existing resources
In market economy like India financial market institutions provide the avenue by which
long-term savings are mobilized and channeled into investments Confidence of the
investors in the market is imperative for the growth and development of the market For
any stock market the market Indices is the barometer of its performance and reflects the
prevailing sentiments of the entire economy Stock index is created to provide investors
with the information regarding the average share price in the stock market The ups and
8
downs in the index represent the movement of the equity market These indices need to
represent the return obtained by typical portfolios in the country
Generally the stock price of any company is vulnerable to three types of news
bull Company specific
bull Industry specific
bull Economy specific
An all share index includes stocks from all the sectors of the economy and thus cancels
out the stock and sector specific news and events that affect stock prices (law of portfolio
diversification) and reflect the overall performance of the companyequity market and the
news affecting it
The most important use of an equity market index is as a benchmark for a portfolio of
stocks All diversified portfolios belonging either to retail investors or mutual funds use
the common stock index as a yardstick for their returns Indices are useful in modern
financial application of derivatives
Capital Market Instruments ndash
some of the capital market instruments are
bull Equity
bull Preference shares
bull Debenture Bonds
bull ADRs GDRs
bull Derivatives
9
2Corporate securities
Shares
The total capital of a company may be divided into small units called shares For
example if the required capital of a company is US $500000 and is divided into 50000
units of US $10 each each unit is called a share of face value US $10 A share may be of
any face value depending upon the capital required and the number of shares into which
it is divided The holders of the shares are called share holders The shares can be
purchased or sold only in integral multiples
Equity shares signify ownership in a corporation and represent claim over the financial
assets and earnings of the corporation Shareholders enjoy voting rights and the right to
receive dividends however in case of liquidation they will receive residuals after all the
creditors of the company are settled in full A company may invite investors to subscribe
for the shares by the way of
bull Public issue through prospectus
bull Tender book building process
bull Offer for sale
bull Placement method
bull Rights issue
Stocks
The word stock refers to the old English law tradition where a share in the capital of the
company was not divided into ldquosharesrdquo of fixed denomination but was issued as one
chunk This concept is no more prevalent but the word ldquostockrdquo continues The word
ldquojoint stock companiesrdquo also refers to this tradition
10
Debt Instruments
A contractual arrangement in which the issuer agrees to pay interest and repay the
borrowed amount after a specified period of time is a debt instrument Certain features
common to all debt instruments are
bull Maturity ndash the number of years over which the issuer agrees to meet the
contractual obligations is the term to maturity Debt instruments are classified on
the basis of the time remaining to maturity
bull Par value ndash the face value or principal value of the debt instrument is called the
par value
bull Coupon rate ndash agreed rate of interest that is paid periodically to the investor and is
calculated as a percentage of the face value Some of the debt instruments may
not have an explicit coupon rate for instance zero coupon bonds These bonds are
issued on discount and redeemed at par Thus the difference between the
investorrsquos investment and return is the interest earned Coupon rates may be fixed
for the term or may be variable
bull Call option ndash option available to the issuer specified in the trust indenture to lsquocall
inrsquo the bonds and repay them at pre determined price before maturity Call feature
acts like a ceiling f or payments The issuer may call the bonds before the stated
maturity as it may recognize that the interest rates may fall below the coupon rate
and redeeming the bonds and replacing them with securities of lower coupon rates
will be economically beneficial It is the same as the prepayment option where
the borrower prepays before scheduled payments or slated maturity
o Some bonds are issued with lsquocall protection feature ie they would not be
11
called for a specified period of time
o Similar to the call option of the issuer there is a put option for the investor
to sell the securities back to the issuer at a predetermined price and date
The investor may do so anticipating rise in the interest rates wherein the
investor would liquidate the funds and alternatively invest in place of
higher interest
bull Refunding provisions ndash in case where the issuer may not have cash to redeem the
debt instruments the issuer may issue new debt instrument and use the proceeds to
repay the securities or to exercise the call option
Debt instruments may be of various kinds depending on the repayment
bull Bullet payment ndash instruments where the issuer agrees to repay the entire amount
at the maturity date ie lumpsum payment is called bullet payment
bull Sinking fund payment ndash instruments where the issuer agrees to retire a specified
portion of the debt each year is called sinking fund requirement
bull Amortization ndash instruments where there are scheduled principal repayments
before maturity date are called amortizing instruments
Debentures Bonds
The term Debenture is derived from the Latin word lsquodeberersquo which means lsquoto owe a
debtrsquo A debenture is an acknowledgment of debt taken either from the public or a
particular source A debenture may be viewed as a loan represented as marketable
security The word ldquobondrdquo may be used interchangeably with debentures
Debt instruments with maturity more than 5 years are called lsquobondsrsquo
Yields
Most common method of calculating the yields on debt instrument is the lsquoyield to
maturityrsquo method the formula is as under
12
Main differences between shares and debentures
bull Share money forms a part of the capital of the company The share holders are
part proprietors of the company whereas debentures are mere debt and debenture
holders are just creditors
bull Share holders get dividend only out of profits and in case of insufficient or no
profits they get nothing and debenture holders being creditors get guaranteed
interest as agreed whether the company makes profit or not
bull Share holders are paid after the debenture holders are paid their due first
bull The dividend on shares depends upon the profit of the company but the interest on
debentures is very well fixed at the time of issue itself
bull Shares are not to be paid back by the company whereas debentures have to be
paid back at the end of a fixed period
bull In case the company is wound up the share holders may lose a part or full of their
capital but he debenture holders invariably get back their investment
bull Investment in shares is riskier as it represents residual interest in the company
Debenture being debt is senior
bull Debentures are quite often secured that is a security interest is created on some
assets to back up debentures There is no question of any security in case of
shares
bull Share holders have a right to attend and vote at the meetings of the share holders
whereas debenture holders have no such rights
13
Quasi debt instruments
Preference shares
Preference shares are different from ordinary equity shares Preference share holders have
the following preferential rights
(i) The right to get a fixed rate of dividend before the payment of dividend to the equity
holders
(ii) The right to get back their capital before the equity holders in case of winding up of
the company
Eligibility norms for public issue ICDR Regulations
IPO
Conditions for IPO (all conditions listed below to be satisfied)
bull Net tangible assets of 3 crore in each of the preceding 3 full years of which not
more than 50 are held in monetary assets
bull Track record of distributable profits for 3 out of the immediately preceding 5
years
bull Net worth of 1 crore in each of the preceding three full years
bull Issue size of proposed issue + all previous issues made in the same financial year
does not exceed 5 times its pre-issue net worth as per the audited balance sheet of
the preceding financial year
bull In case of change of name within the last one year 50 of the revenue for the
preceding 1 full year earned by it from the activity indicated by the new name
14
If the issuer does not satisfy any of the condition listed above issuer may make IPO
by satisfying the following
1 Issue through book building
subject to allotment of 50 of net
offer to public to QIB failing
which full subscription monies to
be refunded
O
R
bull 15 of the cost of the project to
be contributed by SCB or PFI of
which not less than 10 from
the appraisers +
bull allotment of 10 of the net
offer to public to QIB failing
which full subscription monies
to be refunded
2 Minimum post-issue face value
capital of the issuer is 10 crores
O
R
Issuer to provide market-making for 2
yrs from the date of listing of the
specified securities
15
bull Promotersrsquo contribution
o Cannot be less than 20 of the post issue capital
o Maximum not defined but in view of the required minimum public offer as
per Rule 19 (2) (b) of Securities Contracts Regulations promoters
contribution plus any firm allotments cannot exceed 90 or 75 of the issue
size as the case may be (see below)
bull Minimum Public offer By public offer is meant the securities being offered to
public by advertisement exclusive of promotersrsquo contribution and firm allotments
o Rule 19(2)(b) of the Securities Contracts (Regulations) Rules 1957 requires
that the minimum public offer should be 25 of total issued securities should
be offered to public through advertisement
o However a lower public offer of 10 is allowed if the following conditions
are satisfied
1048707 The minimum public offer is Rs 100 crores and the number of
securities being offered to public is at least 20 lakh securities
1048707 The offer is made through mandatory book-building route with
minimum allocation of 60 to QIBs
bull Firm allotment reservations Subject to the minimum public offer norms issuers
are free to make reservations on competitive basis (as defined hereinafter) andor firm
allotments (as defined hereinafter) to various categories of persons for the remaining
part of the issue size
Firm allotment This implies allotment on a firm basis in public issues by an issuing
company Specified Categories for Firm allotment in public issues can be made to the
following
1 Indian and Multilateral Development Financial Institutions
16
2 Indian Mutual Funds
3 Foreign Institutional Investors (including non resident Indians and overseas
corporate bodies)
4 Permanent regular employees of the issuer company ndash maximum 10 of total
proposed issue amount
5 Scheduled Banks
6 Lead Merchant Banker- subject to a ceiling of 5 of the proposed issue
FPO
bull Promotersrsquo contribution
o In case of FPO the promoters should ensure participation either to the extent
of 20 of the proposed issue or their post-issue share holding must be to the
extent of 20 of the post issue capital Requirement to bring in contribution
from promoters shall be optional for a company listed on a stock exchange for
at least 3 years and having a track record of dividend payment of 3 years
immediately preceding the year of issue
o As for maximum promotersrsquo contribution Rule 19 (2) (b) stated above shall
be applicable
o Participation by promoters in excess of above shall be treated as preferential
allotment to which preferential allotment rules will be applicable As for
preferential allotment rules see Notes under sec 81
bull Net Public offer
o The minimum net public offer shall be as per Rule 19 (2) (b) ndash see above
17
bull Firm allotment reservations
o The issuer companies are free to make reservations on competitive basis (as
defined above) andor firm allotments to various categories of persons
enumerated above for the remaining issue size that is after considering
promotersrsquo contribution and public offer
o The reservation on competitive basis may also be made for retail individual
shareholders (RIS) For meaning of the term RIS see under lsquocategories of
investorsrsquo below
Composite Issue
bull Promotersrsquo contribution
o promoters have option to contribute either 20 of the proposed issue or 20
of post issue capital
o the right issue component to be excluded while computing the post-issue
capital
bull Others
o The right issue component to be offered to the existing shareholders
o Except the above the rules of allotment under IPO as above shall apply
Qualified Institutional Placement
Another class of issue not being a rights issue which calls for resolution under sec 81
(1A)
Condition for issue-
bull The equity shares of the same class were listed on a stock exchange having
nation-wide trading terminals for a period of at least one year as on the date of
issuance of notice for issue of shares to QIBs
bull The issue should not violate the prescribed minimum public shareholding
18
requirements specified by the listing agreement
Reservation
bull Minimum of 10 percent of specified securities issued shall be allotted to mutual
funds
bull In case the mutual funds do not agree to take shares issued under this chapter
such shares may be allotted to other QIBs
bull However no allotment shall be made under this chapter either directly or
indirectly to any QIB being a promoter or any person related to promoters
Withdrawal of bid not permitted- Investors shall not be allowed to withdraw their bids
after the closure of issue
Number of allottees-
bull minimum number of allottees shall not be less than
o Two where the issue size is less than or equal to Rs 250 crores
o Five where the issue size is greater than Rs 250 crores
bull No single allottee shall be allotted more than 50 of the issue size
Restrictions-
bull Amount raised through the proposed placement + all previous placements made in
the same financial year shall not exceed five times the net worth of the issuer as
per the audited balance sheet of the previous financial year
bull Lock-in-period of one year from the date of allotment except when sold on a
recognised stock exchange
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
6
1CAPITAL MARKET PRODUCT
What are financial markets
Financial market is a market where financial instruments are exchanged or traded and
helps in determining the prices of the assets that are traded in and is also called the price
discovery process
1 Organizations that facilitate the trade in financial products For eg Stock exchanges
(NYSE Nasdaq) facilitate the trade in stocks bonds and warrants
2 Coming together of buyer and sellers at a common platform to trade financial products
is termed as financial markets ie stocks and shares are traded between buyers and
sellers in a number of ways including the use of stock exchanges directly between
buyers and sellers etc
Financial markets may be classified on the basis of
bull types of claims ndash debt and equity markets
bull maturity ndash money market and capital market
bull trade ndash spot market and delivery market
bull deals in financial claims ndash primary market and secondary market
Indian Financial Market consists of the following markets
bull Capital Market Securities Market
o Primary capital market
o Secondary capital market
bull Money Market
bull Debt Market
7
Capital market and money market
Financial markets can broadly be divided into money and capital market
Money Market Money market is a market for debt securities that pay off in the short term
usually less than one year for example the market for 90-days treasury bills This market
encompasses the trading and issuance of short term non equity debt instruments including
treasury bills commercial papers bankers acceptance certificates of deposits etc
Capital Market Capital market is a market for long-term debt and equity shares In this
market the capital funds comprising of both equity and debt are issued and traded This
also includes private placement sources of debt and equity as well as organized markets
like stock exchanges Capital market includes financial instruments with more than one
year maturity
Significance of Capital Markets
A well functioning stock market may help the development process in an economy
through the following channels
1 Growth of savings
2 Efficient allocation of investment resources
3 Better utilization of the existing resources
In market economy like India financial market institutions provide the avenue by which
long-term savings are mobilized and channeled into investments Confidence of the
investors in the market is imperative for the growth and development of the market For
any stock market the market Indices is the barometer of its performance and reflects the
prevailing sentiments of the entire economy Stock index is created to provide investors
with the information regarding the average share price in the stock market The ups and
8
downs in the index represent the movement of the equity market These indices need to
represent the return obtained by typical portfolios in the country
Generally the stock price of any company is vulnerable to three types of news
bull Company specific
bull Industry specific
bull Economy specific
An all share index includes stocks from all the sectors of the economy and thus cancels
out the stock and sector specific news and events that affect stock prices (law of portfolio
diversification) and reflect the overall performance of the companyequity market and the
news affecting it
The most important use of an equity market index is as a benchmark for a portfolio of
stocks All diversified portfolios belonging either to retail investors or mutual funds use
the common stock index as a yardstick for their returns Indices are useful in modern
financial application of derivatives
Capital Market Instruments ndash
some of the capital market instruments are
bull Equity
bull Preference shares
bull Debenture Bonds
bull ADRs GDRs
bull Derivatives
9
2Corporate securities
Shares
The total capital of a company may be divided into small units called shares For
example if the required capital of a company is US $500000 and is divided into 50000
units of US $10 each each unit is called a share of face value US $10 A share may be of
any face value depending upon the capital required and the number of shares into which
it is divided The holders of the shares are called share holders The shares can be
purchased or sold only in integral multiples
Equity shares signify ownership in a corporation and represent claim over the financial
assets and earnings of the corporation Shareholders enjoy voting rights and the right to
receive dividends however in case of liquidation they will receive residuals after all the
creditors of the company are settled in full A company may invite investors to subscribe
for the shares by the way of
bull Public issue through prospectus
bull Tender book building process
bull Offer for sale
bull Placement method
bull Rights issue
Stocks
The word stock refers to the old English law tradition where a share in the capital of the
company was not divided into ldquosharesrdquo of fixed denomination but was issued as one
chunk This concept is no more prevalent but the word ldquostockrdquo continues The word
ldquojoint stock companiesrdquo also refers to this tradition
10
Debt Instruments
A contractual arrangement in which the issuer agrees to pay interest and repay the
borrowed amount after a specified period of time is a debt instrument Certain features
common to all debt instruments are
bull Maturity ndash the number of years over which the issuer agrees to meet the
contractual obligations is the term to maturity Debt instruments are classified on
the basis of the time remaining to maturity
bull Par value ndash the face value or principal value of the debt instrument is called the
par value
bull Coupon rate ndash agreed rate of interest that is paid periodically to the investor and is
calculated as a percentage of the face value Some of the debt instruments may
not have an explicit coupon rate for instance zero coupon bonds These bonds are
issued on discount and redeemed at par Thus the difference between the
investorrsquos investment and return is the interest earned Coupon rates may be fixed
for the term or may be variable
bull Call option ndash option available to the issuer specified in the trust indenture to lsquocall
inrsquo the bonds and repay them at pre determined price before maturity Call feature
acts like a ceiling f or payments The issuer may call the bonds before the stated
maturity as it may recognize that the interest rates may fall below the coupon rate
and redeeming the bonds and replacing them with securities of lower coupon rates
will be economically beneficial It is the same as the prepayment option where
the borrower prepays before scheduled payments or slated maturity
o Some bonds are issued with lsquocall protection feature ie they would not be
11
called for a specified period of time
o Similar to the call option of the issuer there is a put option for the investor
to sell the securities back to the issuer at a predetermined price and date
The investor may do so anticipating rise in the interest rates wherein the
investor would liquidate the funds and alternatively invest in place of
higher interest
bull Refunding provisions ndash in case where the issuer may not have cash to redeem the
debt instruments the issuer may issue new debt instrument and use the proceeds to
repay the securities or to exercise the call option
Debt instruments may be of various kinds depending on the repayment
bull Bullet payment ndash instruments where the issuer agrees to repay the entire amount
at the maturity date ie lumpsum payment is called bullet payment
bull Sinking fund payment ndash instruments where the issuer agrees to retire a specified
portion of the debt each year is called sinking fund requirement
bull Amortization ndash instruments where there are scheduled principal repayments
before maturity date are called amortizing instruments
Debentures Bonds
The term Debenture is derived from the Latin word lsquodeberersquo which means lsquoto owe a
debtrsquo A debenture is an acknowledgment of debt taken either from the public or a
particular source A debenture may be viewed as a loan represented as marketable
security The word ldquobondrdquo may be used interchangeably with debentures
Debt instruments with maturity more than 5 years are called lsquobondsrsquo
Yields
Most common method of calculating the yields on debt instrument is the lsquoyield to
maturityrsquo method the formula is as under
12
Main differences between shares and debentures
bull Share money forms a part of the capital of the company The share holders are
part proprietors of the company whereas debentures are mere debt and debenture
holders are just creditors
bull Share holders get dividend only out of profits and in case of insufficient or no
profits they get nothing and debenture holders being creditors get guaranteed
interest as agreed whether the company makes profit or not
bull Share holders are paid after the debenture holders are paid their due first
bull The dividend on shares depends upon the profit of the company but the interest on
debentures is very well fixed at the time of issue itself
bull Shares are not to be paid back by the company whereas debentures have to be
paid back at the end of a fixed period
bull In case the company is wound up the share holders may lose a part or full of their
capital but he debenture holders invariably get back their investment
bull Investment in shares is riskier as it represents residual interest in the company
Debenture being debt is senior
bull Debentures are quite often secured that is a security interest is created on some
assets to back up debentures There is no question of any security in case of
shares
bull Share holders have a right to attend and vote at the meetings of the share holders
whereas debenture holders have no such rights
13
Quasi debt instruments
Preference shares
Preference shares are different from ordinary equity shares Preference share holders have
the following preferential rights
(i) The right to get a fixed rate of dividend before the payment of dividend to the equity
holders
(ii) The right to get back their capital before the equity holders in case of winding up of
the company
Eligibility norms for public issue ICDR Regulations
IPO
Conditions for IPO (all conditions listed below to be satisfied)
bull Net tangible assets of 3 crore in each of the preceding 3 full years of which not
more than 50 are held in monetary assets
bull Track record of distributable profits for 3 out of the immediately preceding 5
years
bull Net worth of 1 crore in each of the preceding three full years
bull Issue size of proposed issue + all previous issues made in the same financial year
does not exceed 5 times its pre-issue net worth as per the audited balance sheet of
the preceding financial year
bull In case of change of name within the last one year 50 of the revenue for the
preceding 1 full year earned by it from the activity indicated by the new name
14
If the issuer does not satisfy any of the condition listed above issuer may make IPO
by satisfying the following
1 Issue through book building
subject to allotment of 50 of net
offer to public to QIB failing
which full subscription monies to
be refunded
O
R
bull 15 of the cost of the project to
be contributed by SCB or PFI of
which not less than 10 from
the appraisers +
bull allotment of 10 of the net
offer to public to QIB failing
which full subscription monies
to be refunded
2 Minimum post-issue face value
capital of the issuer is 10 crores
O
R
Issuer to provide market-making for 2
yrs from the date of listing of the
specified securities
15
bull Promotersrsquo contribution
o Cannot be less than 20 of the post issue capital
o Maximum not defined but in view of the required minimum public offer as
per Rule 19 (2) (b) of Securities Contracts Regulations promoters
contribution plus any firm allotments cannot exceed 90 or 75 of the issue
size as the case may be (see below)
bull Minimum Public offer By public offer is meant the securities being offered to
public by advertisement exclusive of promotersrsquo contribution and firm allotments
o Rule 19(2)(b) of the Securities Contracts (Regulations) Rules 1957 requires
that the minimum public offer should be 25 of total issued securities should
be offered to public through advertisement
o However a lower public offer of 10 is allowed if the following conditions
are satisfied
1048707 The minimum public offer is Rs 100 crores and the number of
securities being offered to public is at least 20 lakh securities
1048707 The offer is made through mandatory book-building route with
minimum allocation of 60 to QIBs
bull Firm allotment reservations Subject to the minimum public offer norms issuers
are free to make reservations on competitive basis (as defined hereinafter) andor firm
allotments (as defined hereinafter) to various categories of persons for the remaining
part of the issue size
Firm allotment This implies allotment on a firm basis in public issues by an issuing
company Specified Categories for Firm allotment in public issues can be made to the
following
1 Indian and Multilateral Development Financial Institutions
16
2 Indian Mutual Funds
3 Foreign Institutional Investors (including non resident Indians and overseas
corporate bodies)
4 Permanent regular employees of the issuer company ndash maximum 10 of total
proposed issue amount
5 Scheduled Banks
6 Lead Merchant Banker- subject to a ceiling of 5 of the proposed issue
FPO
bull Promotersrsquo contribution
o In case of FPO the promoters should ensure participation either to the extent
of 20 of the proposed issue or their post-issue share holding must be to the
extent of 20 of the post issue capital Requirement to bring in contribution
from promoters shall be optional for a company listed on a stock exchange for
at least 3 years and having a track record of dividend payment of 3 years
immediately preceding the year of issue
o As for maximum promotersrsquo contribution Rule 19 (2) (b) stated above shall
be applicable
o Participation by promoters in excess of above shall be treated as preferential
allotment to which preferential allotment rules will be applicable As for
preferential allotment rules see Notes under sec 81
bull Net Public offer
o The minimum net public offer shall be as per Rule 19 (2) (b) ndash see above
17
bull Firm allotment reservations
o The issuer companies are free to make reservations on competitive basis (as
defined above) andor firm allotments to various categories of persons
enumerated above for the remaining issue size that is after considering
promotersrsquo contribution and public offer
o The reservation on competitive basis may also be made for retail individual
shareholders (RIS) For meaning of the term RIS see under lsquocategories of
investorsrsquo below
Composite Issue
bull Promotersrsquo contribution
o promoters have option to contribute either 20 of the proposed issue or 20
of post issue capital
o the right issue component to be excluded while computing the post-issue
capital
bull Others
o The right issue component to be offered to the existing shareholders
o Except the above the rules of allotment under IPO as above shall apply
Qualified Institutional Placement
Another class of issue not being a rights issue which calls for resolution under sec 81
(1A)
Condition for issue-
bull The equity shares of the same class were listed on a stock exchange having
nation-wide trading terminals for a period of at least one year as on the date of
issuance of notice for issue of shares to QIBs
bull The issue should not violate the prescribed minimum public shareholding
18
requirements specified by the listing agreement
Reservation
bull Minimum of 10 percent of specified securities issued shall be allotted to mutual
funds
bull In case the mutual funds do not agree to take shares issued under this chapter
such shares may be allotted to other QIBs
bull However no allotment shall be made under this chapter either directly or
indirectly to any QIB being a promoter or any person related to promoters
Withdrawal of bid not permitted- Investors shall not be allowed to withdraw their bids
after the closure of issue
Number of allottees-
bull minimum number of allottees shall not be less than
o Two where the issue size is less than or equal to Rs 250 crores
o Five where the issue size is greater than Rs 250 crores
bull No single allottee shall be allotted more than 50 of the issue size
Restrictions-
bull Amount raised through the proposed placement + all previous placements made in
the same financial year shall not exceed five times the net worth of the issuer as
per the audited balance sheet of the previous financial year
bull Lock-in-period of one year from the date of allotment except when sold on a
recognised stock exchange
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
7
Capital market and money market
Financial markets can broadly be divided into money and capital market
Money Market Money market is a market for debt securities that pay off in the short term
usually less than one year for example the market for 90-days treasury bills This market
encompasses the trading and issuance of short term non equity debt instruments including
treasury bills commercial papers bankers acceptance certificates of deposits etc
Capital Market Capital market is a market for long-term debt and equity shares In this
market the capital funds comprising of both equity and debt are issued and traded This
also includes private placement sources of debt and equity as well as organized markets
like stock exchanges Capital market includes financial instruments with more than one
year maturity
Significance of Capital Markets
A well functioning stock market may help the development process in an economy
through the following channels
1 Growth of savings
2 Efficient allocation of investment resources
3 Better utilization of the existing resources
In market economy like India financial market institutions provide the avenue by which
long-term savings are mobilized and channeled into investments Confidence of the
investors in the market is imperative for the growth and development of the market For
any stock market the market Indices is the barometer of its performance and reflects the
prevailing sentiments of the entire economy Stock index is created to provide investors
with the information regarding the average share price in the stock market The ups and
8
downs in the index represent the movement of the equity market These indices need to
represent the return obtained by typical portfolios in the country
Generally the stock price of any company is vulnerable to three types of news
bull Company specific
bull Industry specific
bull Economy specific
An all share index includes stocks from all the sectors of the economy and thus cancels
out the stock and sector specific news and events that affect stock prices (law of portfolio
diversification) and reflect the overall performance of the companyequity market and the
news affecting it
The most important use of an equity market index is as a benchmark for a portfolio of
stocks All diversified portfolios belonging either to retail investors or mutual funds use
the common stock index as a yardstick for their returns Indices are useful in modern
financial application of derivatives
Capital Market Instruments ndash
some of the capital market instruments are
bull Equity
bull Preference shares
bull Debenture Bonds
bull ADRs GDRs
bull Derivatives
9
2Corporate securities
Shares
The total capital of a company may be divided into small units called shares For
example if the required capital of a company is US $500000 and is divided into 50000
units of US $10 each each unit is called a share of face value US $10 A share may be of
any face value depending upon the capital required and the number of shares into which
it is divided The holders of the shares are called share holders The shares can be
purchased or sold only in integral multiples
Equity shares signify ownership in a corporation and represent claim over the financial
assets and earnings of the corporation Shareholders enjoy voting rights and the right to
receive dividends however in case of liquidation they will receive residuals after all the
creditors of the company are settled in full A company may invite investors to subscribe
for the shares by the way of
bull Public issue through prospectus
bull Tender book building process
bull Offer for sale
bull Placement method
bull Rights issue
Stocks
The word stock refers to the old English law tradition where a share in the capital of the
company was not divided into ldquosharesrdquo of fixed denomination but was issued as one
chunk This concept is no more prevalent but the word ldquostockrdquo continues The word
ldquojoint stock companiesrdquo also refers to this tradition
10
Debt Instruments
A contractual arrangement in which the issuer agrees to pay interest and repay the
borrowed amount after a specified period of time is a debt instrument Certain features
common to all debt instruments are
bull Maturity ndash the number of years over which the issuer agrees to meet the
contractual obligations is the term to maturity Debt instruments are classified on
the basis of the time remaining to maturity
bull Par value ndash the face value or principal value of the debt instrument is called the
par value
bull Coupon rate ndash agreed rate of interest that is paid periodically to the investor and is
calculated as a percentage of the face value Some of the debt instruments may
not have an explicit coupon rate for instance zero coupon bonds These bonds are
issued on discount and redeemed at par Thus the difference between the
investorrsquos investment and return is the interest earned Coupon rates may be fixed
for the term or may be variable
bull Call option ndash option available to the issuer specified in the trust indenture to lsquocall
inrsquo the bonds and repay them at pre determined price before maturity Call feature
acts like a ceiling f or payments The issuer may call the bonds before the stated
maturity as it may recognize that the interest rates may fall below the coupon rate
and redeeming the bonds and replacing them with securities of lower coupon rates
will be economically beneficial It is the same as the prepayment option where
the borrower prepays before scheduled payments or slated maturity
o Some bonds are issued with lsquocall protection feature ie they would not be
11
called for a specified period of time
o Similar to the call option of the issuer there is a put option for the investor
to sell the securities back to the issuer at a predetermined price and date
The investor may do so anticipating rise in the interest rates wherein the
investor would liquidate the funds and alternatively invest in place of
higher interest
bull Refunding provisions ndash in case where the issuer may not have cash to redeem the
debt instruments the issuer may issue new debt instrument and use the proceeds to
repay the securities or to exercise the call option
Debt instruments may be of various kinds depending on the repayment
bull Bullet payment ndash instruments where the issuer agrees to repay the entire amount
at the maturity date ie lumpsum payment is called bullet payment
bull Sinking fund payment ndash instruments where the issuer agrees to retire a specified
portion of the debt each year is called sinking fund requirement
bull Amortization ndash instruments where there are scheduled principal repayments
before maturity date are called amortizing instruments
Debentures Bonds
The term Debenture is derived from the Latin word lsquodeberersquo which means lsquoto owe a
debtrsquo A debenture is an acknowledgment of debt taken either from the public or a
particular source A debenture may be viewed as a loan represented as marketable
security The word ldquobondrdquo may be used interchangeably with debentures
Debt instruments with maturity more than 5 years are called lsquobondsrsquo
Yields
Most common method of calculating the yields on debt instrument is the lsquoyield to
maturityrsquo method the formula is as under
12
Main differences between shares and debentures
bull Share money forms a part of the capital of the company The share holders are
part proprietors of the company whereas debentures are mere debt and debenture
holders are just creditors
bull Share holders get dividend only out of profits and in case of insufficient or no
profits they get nothing and debenture holders being creditors get guaranteed
interest as agreed whether the company makes profit or not
bull Share holders are paid after the debenture holders are paid their due first
bull The dividend on shares depends upon the profit of the company but the interest on
debentures is very well fixed at the time of issue itself
bull Shares are not to be paid back by the company whereas debentures have to be
paid back at the end of a fixed period
bull In case the company is wound up the share holders may lose a part or full of their
capital but he debenture holders invariably get back their investment
bull Investment in shares is riskier as it represents residual interest in the company
Debenture being debt is senior
bull Debentures are quite often secured that is a security interest is created on some
assets to back up debentures There is no question of any security in case of
shares
bull Share holders have a right to attend and vote at the meetings of the share holders
whereas debenture holders have no such rights
13
Quasi debt instruments
Preference shares
Preference shares are different from ordinary equity shares Preference share holders have
the following preferential rights
(i) The right to get a fixed rate of dividend before the payment of dividend to the equity
holders
(ii) The right to get back their capital before the equity holders in case of winding up of
the company
Eligibility norms for public issue ICDR Regulations
IPO
Conditions for IPO (all conditions listed below to be satisfied)
bull Net tangible assets of 3 crore in each of the preceding 3 full years of which not
more than 50 are held in monetary assets
bull Track record of distributable profits for 3 out of the immediately preceding 5
years
bull Net worth of 1 crore in each of the preceding three full years
bull Issue size of proposed issue + all previous issues made in the same financial year
does not exceed 5 times its pre-issue net worth as per the audited balance sheet of
the preceding financial year
bull In case of change of name within the last one year 50 of the revenue for the
preceding 1 full year earned by it from the activity indicated by the new name
14
If the issuer does not satisfy any of the condition listed above issuer may make IPO
by satisfying the following
1 Issue through book building
subject to allotment of 50 of net
offer to public to QIB failing
which full subscription monies to
be refunded
O
R
bull 15 of the cost of the project to
be contributed by SCB or PFI of
which not less than 10 from
the appraisers +
bull allotment of 10 of the net
offer to public to QIB failing
which full subscription monies
to be refunded
2 Minimum post-issue face value
capital of the issuer is 10 crores
O
R
Issuer to provide market-making for 2
yrs from the date of listing of the
specified securities
15
bull Promotersrsquo contribution
o Cannot be less than 20 of the post issue capital
o Maximum not defined but in view of the required minimum public offer as
per Rule 19 (2) (b) of Securities Contracts Regulations promoters
contribution plus any firm allotments cannot exceed 90 or 75 of the issue
size as the case may be (see below)
bull Minimum Public offer By public offer is meant the securities being offered to
public by advertisement exclusive of promotersrsquo contribution and firm allotments
o Rule 19(2)(b) of the Securities Contracts (Regulations) Rules 1957 requires
that the minimum public offer should be 25 of total issued securities should
be offered to public through advertisement
o However a lower public offer of 10 is allowed if the following conditions
are satisfied
1048707 The minimum public offer is Rs 100 crores and the number of
securities being offered to public is at least 20 lakh securities
1048707 The offer is made through mandatory book-building route with
minimum allocation of 60 to QIBs
bull Firm allotment reservations Subject to the minimum public offer norms issuers
are free to make reservations on competitive basis (as defined hereinafter) andor firm
allotments (as defined hereinafter) to various categories of persons for the remaining
part of the issue size
Firm allotment This implies allotment on a firm basis in public issues by an issuing
company Specified Categories for Firm allotment in public issues can be made to the
following
1 Indian and Multilateral Development Financial Institutions
16
2 Indian Mutual Funds
3 Foreign Institutional Investors (including non resident Indians and overseas
corporate bodies)
4 Permanent regular employees of the issuer company ndash maximum 10 of total
proposed issue amount
5 Scheduled Banks
6 Lead Merchant Banker- subject to a ceiling of 5 of the proposed issue
FPO
bull Promotersrsquo contribution
o In case of FPO the promoters should ensure participation either to the extent
of 20 of the proposed issue or their post-issue share holding must be to the
extent of 20 of the post issue capital Requirement to bring in contribution
from promoters shall be optional for a company listed on a stock exchange for
at least 3 years and having a track record of dividend payment of 3 years
immediately preceding the year of issue
o As for maximum promotersrsquo contribution Rule 19 (2) (b) stated above shall
be applicable
o Participation by promoters in excess of above shall be treated as preferential
allotment to which preferential allotment rules will be applicable As for
preferential allotment rules see Notes under sec 81
bull Net Public offer
o The minimum net public offer shall be as per Rule 19 (2) (b) ndash see above
17
bull Firm allotment reservations
o The issuer companies are free to make reservations on competitive basis (as
defined above) andor firm allotments to various categories of persons
enumerated above for the remaining issue size that is after considering
promotersrsquo contribution and public offer
o The reservation on competitive basis may also be made for retail individual
shareholders (RIS) For meaning of the term RIS see under lsquocategories of
investorsrsquo below
Composite Issue
bull Promotersrsquo contribution
o promoters have option to contribute either 20 of the proposed issue or 20
of post issue capital
o the right issue component to be excluded while computing the post-issue
capital
bull Others
o The right issue component to be offered to the existing shareholders
o Except the above the rules of allotment under IPO as above shall apply
Qualified Institutional Placement
Another class of issue not being a rights issue which calls for resolution under sec 81
(1A)
Condition for issue-
bull The equity shares of the same class were listed on a stock exchange having
nation-wide trading terminals for a period of at least one year as on the date of
issuance of notice for issue of shares to QIBs
bull The issue should not violate the prescribed minimum public shareholding
18
requirements specified by the listing agreement
Reservation
bull Minimum of 10 percent of specified securities issued shall be allotted to mutual
funds
bull In case the mutual funds do not agree to take shares issued under this chapter
such shares may be allotted to other QIBs
bull However no allotment shall be made under this chapter either directly or
indirectly to any QIB being a promoter or any person related to promoters
Withdrawal of bid not permitted- Investors shall not be allowed to withdraw their bids
after the closure of issue
Number of allottees-
bull minimum number of allottees shall not be less than
o Two where the issue size is less than or equal to Rs 250 crores
o Five where the issue size is greater than Rs 250 crores
bull No single allottee shall be allotted more than 50 of the issue size
Restrictions-
bull Amount raised through the proposed placement + all previous placements made in
the same financial year shall not exceed five times the net worth of the issuer as
per the audited balance sheet of the previous financial year
bull Lock-in-period of one year from the date of allotment except when sold on a
recognised stock exchange
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
8
downs in the index represent the movement of the equity market These indices need to
represent the return obtained by typical portfolios in the country
Generally the stock price of any company is vulnerable to three types of news
bull Company specific
bull Industry specific
bull Economy specific
An all share index includes stocks from all the sectors of the economy and thus cancels
out the stock and sector specific news and events that affect stock prices (law of portfolio
diversification) and reflect the overall performance of the companyequity market and the
news affecting it
The most important use of an equity market index is as a benchmark for a portfolio of
stocks All diversified portfolios belonging either to retail investors or mutual funds use
the common stock index as a yardstick for their returns Indices are useful in modern
financial application of derivatives
Capital Market Instruments ndash
some of the capital market instruments are
bull Equity
bull Preference shares
bull Debenture Bonds
bull ADRs GDRs
bull Derivatives
9
2Corporate securities
Shares
The total capital of a company may be divided into small units called shares For
example if the required capital of a company is US $500000 and is divided into 50000
units of US $10 each each unit is called a share of face value US $10 A share may be of
any face value depending upon the capital required and the number of shares into which
it is divided The holders of the shares are called share holders The shares can be
purchased or sold only in integral multiples
Equity shares signify ownership in a corporation and represent claim over the financial
assets and earnings of the corporation Shareholders enjoy voting rights and the right to
receive dividends however in case of liquidation they will receive residuals after all the
creditors of the company are settled in full A company may invite investors to subscribe
for the shares by the way of
bull Public issue through prospectus
bull Tender book building process
bull Offer for sale
bull Placement method
bull Rights issue
Stocks
The word stock refers to the old English law tradition where a share in the capital of the
company was not divided into ldquosharesrdquo of fixed denomination but was issued as one
chunk This concept is no more prevalent but the word ldquostockrdquo continues The word
ldquojoint stock companiesrdquo also refers to this tradition
10
Debt Instruments
A contractual arrangement in which the issuer agrees to pay interest and repay the
borrowed amount after a specified period of time is a debt instrument Certain features
common to all debt instruments are
bull Maturity ndash the number of years over which the issuer agrees to meet the
contractual obligations is the term to maturity Debt instruments are classified on
the basis of the time remaining to maturity
bull Par value ndash the face value or principal value of the debt instrument is called the
par value
bull Coupon rate ndash agreed rate of interest that is paid periodically to the investor and is
calculated as a percentage of the face value Some of the debt instruments may
not have an explicit coupon rate for instance zero coupon bonds These bonds are
issued on discount and redeemed at par Thus the difference between the
investorrsquos investment and return is the interest earned Coupon rates may be fixed
for the term or may be variable
bull Call option ndash option available to the issuer specified in the trust indenture to lsquocall
inrsquo the bonds and repay them at pre determined price before maturity Call feature
acts like a ceiling f or payments The issuer may call the bonds before the stated
maturity as it may recognize that the interest rates may fall below the coupon rate
and redeeming the bonds and replacing them with securities of lower coupon rates
will be economically beneficial It is the same as the prepayment option where
the borrower prepays before scheduled payments or slated maturity
o Some bonds are issued with lsquocall protection feature ie they would not be
11
called for a specified period of time
o Similar to the call option of the issuer there is a put option for the investor
to sell the securities back to the issuer at a predetermined price and date
The investor may do so anticipating rise in the interest rates wherein the
investor would liquidate the funds and alternatively invest in place of
higher interest
bull Refunding provisions ndash in case where the issuer may not have cash to redeem the
debt instruments the issuer may issue new debt instrument and use the proceeds to
repay the securities or to exercise the call option
Debt instruments may be of various kinds depending on the repayment
bull Bullet payment ndash instruments where the issuer agrees to repay the entire amount
at the maturity date ie lumpsum payment is called bullet payment
bull Sinking fund payment ndash instruments where the issuer agrees to retire a specified
portion of the debt each year is called sinking fund requirement
bull Amortization ndash instruments where there are scheduled principal repayments
before maturity date are called amortizing instruments
Debentures Bonds
The term Debenture is derived from the Latin word lsquodeberersquo which means lsquoto owe a
debtrsquo A debenture is an acknowledgment of debt taken either from the public or a
particular source A debenture may be viewed as a loan represented as marketable
security The word ldquobondrdquo may be used interchangeably with debentures
Debt instruments with maturity more than 5 years are called lsquobondsrsquo
Yields
Most common method of calculating the yields on debt instrument is the lsquoyield to
maturityrsquo method the formula is as under
12
Main differences between shares and debentures
bull Share money forms a part of the capital of the company The share holders are
part proprietors of the company whereas debentures are mere debt and debenture
holders are just creditors
bull Share holders get dividend only out of profits and in case of insufficient or no
profits they get nothing and debenture holders being creditors get guaranteed
interest as agreed whether the company makes profit or not
bull Share holders are paid after the debenture holders are paid their due first
bull The dividend on shares depends upon the profit of the company but the interest on
debentures is very well fixed at the time of issue itself
bull Shares are not to be paid back by the company whereas debentures have to be
paid back at the end of a fixed period
bull In case the company is wound up the share holders may lose a part or full of their
capital but he debenture holders invariably get back their investment
bull Investment in shares is riskier as it represents residual interest in the company
Debenture being debt is senior
bull Debentures are quite often secured that is a security interest is created on some
assets to back up debentures There is no question of any security in case of
shares
bull Share holders have a right to attend and vote at the meetings of the share holders
whereas debenture holders have no such rights
13
Quasi debt instruments
Preference shares
Preference shares are different from ordinary equity shares Preference share holders have
the following preferential rights
(i) The right to get a fixed rate of dividend before the payment of dividend to the equity
holders
(ii) The right to get back their capital before the equity holders in case of winding up of
the company
Eligibility norms for public issue ICDR Regulations
IPO
Conditions for IPO (all conditions listed below to be satisfied)
bull Net tangible assets of 3 crore in each of the preceding 3 full years of which not
more than 50 are held in monetary assets
bull Track record of distributable profits for 3 out of the immediately preceding 5
years
bull Net worth of 1 crore in each of the preceding three full years
bull Issue size of proposed issue + all previous issues made in the same financial year
does not exceed 5 times its pre-issue net worth as per the audited balance sheet of
the preceding financial year
bull In case of change of name within the last one year 50 of the revenue for the
preceding 1 full year earned by it from the activity indicated by the new name
14
If the issuer does not satisfy any of the condition listed above issuer may make IPO
by satisfying the following
1 Issue through book building
subject to allotment of 50 of net
offer to public to QIB failing
which full subscription monies to
be refunded
O
R
bull 15 of the cost of the project to
be contributed by SCB or PFI of
which not less than 10 from
the appraisers +
bull allotment of 10 of the net
offer to public to QIB failing
which full subscription monies
to be refunded
2 Minimum post-issue face value
capital of the issuer is 10 crores
O
R
Issuer to provide market-making for 2
yrs from the date of listing of the
specified securities
15
bull Promotersrsquo contribution
o Cannot be less than 20 of the post issue capital
o Maximum not defined but in view of the required minimum public offer as
per Rule 19 (2) (b) of Securities Contracts Regulations promoters
contribution plus any firm allotments cannot exceed 90 or 75 of the issue
size as the case may be (see below)
bull Minimum Public offer By public offer is meant the securities being offered to
public by advertisement exclusive of promotersrsquo contribution and firm allotments
o Rule 19(2)(b) of the Securities Contracts (Regulations) Rules 1957 requires
that the minimum public offer should be 25 of total issued securities should
be offered to public through advertisement
o However a lower public offer of 10 is allowed if the following conditions
are satisfied
1048707 The minimum public offer is Rs 100 crores and the number of
securities being offered to public is at least 20 lakh securities
1048707 The offer is made through mandatory book-building route with
minimum allocation of 60 to QIBs
bull Firm allotment reservations Subject to the minimum public offer norms issuers
are free to make reservations on competitive basis (as defined hereinafter) andor firm
allotments (as defined hereinafter) to various categories of persons for the remaining
part of the issue size
Firm allotment This implies allotment on a firm basis in public issues by an issuing
company Specified Categories for Firm allotment in public issues can be made to the
following
1 Indian and Multilateral Development Financial Institutions
16
2 Indian Mutual Funds
3 Foreign Institutional Investors (including non resident Indians and overseas
corporate bodies)
4 Permanent regular employees of the issuer company ndash maximum 10 of total
proposed issue amount
5 Scheduled Banks
6 Lead Merchant Banker- subject to a ceiling of 5 of the proposed issue
FPO
bull Promotersrsquo contribution
o In case of FPO the promoters should ensure participation either to the extent
of 20 of the proposed issue or their post-issue share holding must be to the
extent of 20 of the post issue capital Requirement to bring in contribution
from promoters shall be optional for a company listed on a stock exchange for
at least 3 years and having a track record of dividend payment of 3 years
immediately preceding the year of issue
o As for maximum promotersrsquo contribution Rule 19 (2) (b) stated above shall
be applicable
o Participation by promoters in excess of above shall be treated as preferential
allotment to which preferential allotment rules will be applicable As for
preferential allotment rules see Notes under sec 81
bull Net Public offer
o The minimum net public offer shall be as per Rule 19 (2) (b) ndash see above
17
bull Firm allotment reservations
o The issuer companies are free to make reservations on competitive basis (as
defined above) andor firm allotments to various categories of persons
enumerated above for the remaining issue size that is after considering
promotersrsquo contribution and public offer
o The reservation on competitive basis may also be made for retail individual
shareholders (RIS) For meaning of the term RIS see under lsquocategories of
investorsrsquo below
Composite Issue
bull Promotersrsquo contribution
o promoters have option to contribute either 20 of the proposed issue or 20
of post issue capital
o the right issue component to be excluded while computing the post-issue
capital
bull Others
o The right issue component to be offered to the existing shareholders
o Except the above the rules of allotment under IPO as above shall apply
Qualified Institutional Placement
Another class of issue not being a rights issue which calls for resolution under sec 81
(1A)
Condition for issue-
bull The equity shares of the same class were listed on a stock exchange having
nation-wide trading terminals for a period of at least one year as on the date of
issuance of notice for issue of shares to QIBs
bull The issue should not violate the prescribed minimum public shareholding
18
requirements specified by the listing agreement
Reservation
bull Minimum of 10 percent of specified securities issued shall be allotted to mutual
funds
bull In case the mutual funds do not agree to take shares issued under this chapter
such shares may be allotted to other QIBs
bull However no allotment shall be made under this chapter either directly or
indirectly to any QIB being a promoter or any person related to promoters
Withdrawal of bid not permitted- Investors shall not be allowed to withdraw their bids
after the closure of issue
Number of allottees-
bull minimum number of allottees shall not be less than
o Two where the issue size is less than or equal to Rs 250 crores
o Five where the issue size is greater than Rs 250 crores
bull No single allottee shall be allotted more than 50 of the issue size
Restrictions-
bull Amount raised through the proposed placement + all previous placements made in
the same financial year shall not exceed five times the net worth of the issuer as
per the audited balance sheet of the previous financial year
bull Lock-in-period of one year from the date of allotment except when sold on a
recognised stock exchange
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
9
2Corporate securities
Shares
The total capital of a company may be divided into small units called shares For
example if the required capital of a company is US $500000 and is divided into 50000
units of US $10 each each unit is called a share of face value US $10 A share may be of
any face value depending upon the capital required and the number of shares into which
it is divided The holders of the shares are called share holders The shares can be
purchased or sold only in integral multiples
Equity shares signify ownership in a corporation and represent claim over the financial
assets and earnings of the corporation Shareholders enjoy voting rights and the right to
receive dividends however in case of liquidation they will receive residuals after all the
creditors of the company are settled in full A company may invite investors to subscribe
for the shares by the way of
bull Public issue through prospectus
bull Tender book building process
bull Offer for sale
bull Placement method
bull Rights issue
Stocks
The word stock refers to the old English law tradition where a share in the capital of the
company was not divided into ldquosharesrdquo of fixed denomination but was issued as one
chunk This concept is no more prevalent but the word ldquostockrdquo continues The word
ldquojoint stock companiesrdquo also refers to this tradition
10
Debt Instruments
A contractual arrangement in which the issuer agrees to pay interest and repay the
borrowed amount after a specified period of time is a debt instrument Certain features
common to all debt instruments are
bull Maturity ndash the number of years over which the issuer agrees to meet the
contractual obligations is the term to maturity Debt instruments are classified on
the basis of the time remaining to maturity
bull Par value ndash the face value or principal value of the debt instrument is called the
par value
bull Coupon rate ndash agreed rate of interest that is paid periodically to the investor and is
calculated as a percentage of the face value Some of the debt instruments may
not have an explicit coupon rate for instance zero coupon bonds These bonds are
issued on discount and redeemed at par Thus the difference between the
investorrsquos investment and return is the interest earned Coupon rates may be fixed
for the term or may be variable
bull Call option ndash option available to the issuer specified in the trust indenture to lsquocall
inrsquo the bonds and repay them at pre determined price before maturity Call feature
acts like a ceiling f or payments The issuer may call the bonds before the stated
maturity as it may recognize that the interest rates may fall below the coupon rate
and redeeming the bonds and replacing them with securities of lower coupon rates
will be economically beneficial It is the same as the prepayment option where
the borrower prepays before scheduled payments or slated maturity
o Some bonds are issued with lsquocall protection feature ie they would not be
11
called for a specified period of time
o Similar to the call option of the issuer there is a put option for the investor
to sell the securities back to the issuer at a predetermined price and date
The investor may do so anticipating rise in the interest rates wherein the
investor would liquidate the funds and alternatively invest in place of
higher interest
bull Refunding provisions ndash in case where the issuer may not have cash to redeem the
debt instruments the issuer may issue new debt instrument and use the proceeds to
repay the securities or to exercise the call option
Debt instruments may be of various kinds depending on the repayment
bull Bullet payment ndash instruments where the issuer agrees to repay the entire amount
at the maturity date ie lumpsum payment is called bullet payment
bull Sinking fund payment ndash instruments where the issuer agrees to retire a specified
portion of the debt each year is called sinking fund requirement
bull Amortization ndash instruments where there are scheduled principal repayments
before maturity date are called amortizing instruments
Debentures Bonds
The term Debenture is derived from the Latin word lsquodeberersquo which means lsquoto owe a
debtrsquo A debenture is an acknowledgment of debt taken either from the public or a
particular source A debenture may be viewed as a loan represented as marketable
security The word ldquobondrdquo may be used interchangeably with debentures
Debt instruments with maturity more than 5 years are called lsquobondsrsquo
Yields
Most common method of calculating the yields on debt instrument is the lsquoyield to
maturityrsquo method the formula is as under
12
Main differences between shares and debentures
bull Share money forms a part of the capital of the company The share holders are
part proprietors of the company whereas debentures are mere debt and debenture
holders are just creditors
bull Share holders get dividend only out of profits and in case of insufficient or no
profits they get nothing and debenture holders being creditors get guaranteed
interest as agreed whether the company makes profit or not
bull Share holders are paid after the debenture holders are paid their due first
bull The dividend on shares depends upon the profit of the company but the interest on
debentures is very well fixed at the time of issue itself
bull Shares are not to be paid back by the company whereas debentures have to be
paid back at the end of a fixed period
bull In case the company is wound up the share holders may lose a part or full of their
capital but he debenture holders invariably get back their investment
bull Investment in shares is riskier as it represents residual interest in the company
Debenture being debt is senior
bull Debentures are quite often secured that is a security interest is created on some
assets to back up debentures There is no question of any security in case of
shares
bull Share holders have a right to attend and vote at the meetings of the share holders
whereas debenture holders have no such rights
13
Quasi debt instruments
Preference shares
Preference shares are different from ordinary equity shares Preference share holders have
the following preferential rights
(i) The right to get a fixed rate of dividend before the payment of dividend to the equity
holders
(ii) The right to get back their capital before the equity holders in case of winding up of
the company
Eligibility norms for public issue ICDR Regulations
IPO
Conditions for IPO (all conditions listed below to be satisfied)
bull Net tangible assets of 3 crore in each of the preceding 3 full years of which not
more than 50 are held in monetary assets
bull Track record of distributable profits for 3 out of the immediately preceding 5
years
bull Net worth of 1 crore in each of the preceding three full years
bull Issue size of proposed issue + all previous issues made in the same financial year
does not exceed 5 times its pre-issue net worth as per the audited balance sheet of
the preceding financial year
bull In case of change of name within the last one year 50 of the revenue for the
preceding 1 full year earned by it from the activity indicated by the new name
14
If the issuer does not satisfy any of the condition listed above issuer may make IPO
by satisfying the following
1 Issue through book building
subject to allotment of 50 of net
offer to public to QIB failing
which full subscription monies to
be refunded
O
R
bull 15 of the cost of the project to
be contributed by SCB or PFI of
which not less than 10 from
the appraisers +
bull allotment of 10 of the net
offer to public to QIB failing
which full subscription monies
to be refunded
2 Minimum post-issue face value
capital of the issuer is 10 crores
O
R
Issuer to provide market-making for 2
yrs from the date of listing of the
specified securities
15
bull Promotersrsquo contribution
o Cannot be less than 20 of the post issue capital
o Maximum not defined but in view of the required minimum public offer as
per Rule 19 (2) (b) of Securities Contracts Regulations promoters
contribution plus any firm allotments cannot exceed 90 or 75 of the issue
size as the case may be (see below)
bull Minimum Public offer By public offer is meant the securities being offered to
public by advertisement exclusive of promotersrsquo contribution and firm allotments
o Rule 19(2)(b) of the Securities Contracts (Regulations) Rules 1957 requires
that the minimum public offer should be 25 of total issued securities should
be offered to public through advertisement
o However a lower public offer of 10 is allowed if the following conditions
are satisfied
1048707 The minimum public offer is Rs 100 crores and the number of
securities being offered to public is at least 20 lakh securities
1048707 The offer is made through mandatory book-building route with
minimum allocation of 60 to QIBs
bull Firm allotment reservations Subject to the minimum public offer norms issuers
are free to make reservations on competitive basis (as defined hereinafter) andor firm
allotments (as defined hereinafter) to various categories of persons for the remaining
part of the issue size
Firm allotment This implies allotment on a firm basis in public issues by an issuing
company Specified Categories for Firm allotment in public issues can be made to the
following
1 Indian and Multilateral Development Financial Institutions
16
2 Indian Mutual Funds
3 Foreign Institutional Investors (including non resident Indians and overseas
corporate bodies)
4 Permanent regular employees of the issuer company ndash maximum 10 of total
proposed issue amount
5 Scheduled Banks
6 Lead Merchant Banker- subject to a ceiling of 5 of the proposed issue
FPO
bull Promotersrsquo contribution
o In case of FPO the promoters should ensure participation either to the extent
of 20 of the proposed issue or their post-issue share holding must be to the
extent of 20 of the post issue capital Requirement to bring in contribution
from promoters shall be optional for a company listed on a stock exchange for
at least 3 years and having a track record of dividend payment of 3 years
immediately preceding the year of issue
o As for maximum promotersrsquo contribution Rule 19 (2) (b) stated above shall
be applicable
o Participation by promoters in excess of above shall be treated as preferential
allotment to which preferential allotment rules will be applicable As for
preferential allotment rules see Notes under sec 81
bull Net Public offer
o The minimum net public offer shall be as per Rule 19 (2) (b) ndash see above
17
bull Firm allotment reservations
o The issuer companies are free to make reservations on competitive basis (as
defined above) andor firm allotments to various categories of persons
enumerated above for the remaining issue size that is after considering
promotersrsquo contribution and public offer
o The reservation on competitive basis may also be made for retail individual
shareholders (RIS) For meaning of the term RIS see under lsquocategories of
investorsrsquo below
Composite Issue
bull Promotersrsquo contribution
o promoters have option to contribute either 20 of the proposed issue or 20
of post issue capital
o the right issue component to be excluded while computing the post-issue
capital
bull Others
o The right issue component to be offered to the existing shareholders
o Except the above the rules of allotment under IPO as above shall apply
Qualified Institutional Placement
Another class of issue not being a rights issue which calls for resolution under sec 81
(1A)
Condition for issue-
bull The equity shares of the same class were listed on a stock exchange having
nation-wide trading terminals for a period of at least one year as on the date of
issuance of notice for issue of shares to QIBs
bull The issue should not violate the prescribed minimum public shareholding
18
requirements specified by the listing agreement
Reservation
bull Minimum of 10 percent of specified securities issued shall be allotted to mutual
funds
bull In case the mutual funds do not agree to take shares issued under this chapter
such shares may be allotted to other QIBs
bull However no allotment shall be made under this chapter either directly or
indirectly to any QIB being a promoter or any person related to promoters
Withdrawal of bid not permitted- Investors shall not be allowed to withdraw their bids
after the closure of issue
Number of allottees-
bull minimum number of allottees shall not be less than
o Two where the issue size is less than or equal to Rs 250 crores
o Five where the issue size is greater than Rs 250 crores
bull No single allottee shall be allotted more than 50 of the issue size
Restrictions-
bull Amount raised through the proposed placement + all previous placements made in
the same financial year shall not exceed five times the net worth of the issuer as
per the audited balance sheet of the previous financial year
bull Lock-in-period of one year from the date of allotment except when sold on a
recognised stock exchange
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
10
Debt Instruments
A contractual arrangement in which the issuer agrees to pay interest and repay the
borrowed amount after a specified period of time is a debt instrument Certain features
common to all debt instruments are
bull Maturity ndash the number of years over which the issuer agrees to meet the
contractual obligations is the term to maturity Debt instruments are classified on
the basis of the time remaining to maturity
bull Par value ndash the face value or principal value of the debt instrument is called the
par value
bull Coupon rate ndash agreed rate of interest that is paid periodically to the investor and is
calculated as a percentage of the face value Some of the debt instruments may
not have an explicit coupon rate for instance zero coupon bonds These bonds are
issued on discount and redeemed at par Thus the difference between the
investorrsquos investment and return is the interest earned Coupon rates may be fixed
for the term or may be variable
bull Call option ndash option available to the issuer specified in the trust indenture to lsquocall
inrsquo the bonds and repay them at pre determined price before maturity Call feature
acts like a ceiling f or payments The issuer may call the bonds before the stated
maturity as it may recognize that the interest rates may fall below the coupon rate
and redeeming the bonds and replacing them with securities of lower coupon rates
will be economically beneficial It is the same as the prepayment option where
the borrower prepays before scheduled payments or slated maturity
o Some bonds are issued with lsquocall protection feature ie they would not be
11
called for a specified period of time
o Similar to the call option of the issuer there is a put option for the investor
to sell the securities back to the issuer at a predetermined price and date
The investor may do so anticipating rise in the interest rates wherein the
investor would liquidate the funds and alternatively invest in place of
higher interest
bull Refunding provisions ndash in case where the issuer may not have cash to redeem the
debt instruments the issuer may issue new debt instrument and use the proceeds to
repay the securities or to exercise the call option
Debt instruments may be of various kinds depending on the repayment
bull Bullet payment ndash instruments where the issuer agrees to repay the entire amount
at the maturity date ie lumpsum payment is called bullet payment
bull Sinking fund payment ndash instruments where the issuer agrees to retire a specified
portion of the debt each year is called sinking fund requirement
bull Amortization ndash instruments where there are scheduled principal repayments
before maturity date are called amortizing instruments
Debentures Bonds
The term Debenture is derived from the Latin word lsquodeberersquo which means lsquoto owe a
debtrsquo A debenture is an acknowledgment of debt taken either from the public or a
particular source A debenture may be viewed as a loan represented as marketable
security The word ldquobondrdquo may be used interchangeably with debentures
Debt instruments with maturity more than 5 years are called lsquobondsrsquo
Yields
Most common method of calculating the yields on debt instrument is the lsquoyield to
maturityrsquo method the formula is as under
12
Main differences between shares and debentures
bull Share money forms a part of the capital of the company The share holders are
part proprietors of the company whereas debentures are mere debt and debenture
holders are just creditors
bull Share holders get dividend only out of profits and in case of insufficient or no
profits they get nothing and debenture holders being creditors get guaranteed
interest as agreed whether the company makes profit or not
bull Share holders are paid after the debenture holders are paid their due first
bull The dividend on shares depends upon the profit of the company but the interest on
debentures is very well fixed at the time of issue itself
bull Shares are not to be paid back by the company whereas debentures have to be
paid back at the end of a fixed period
bull In case the company is wound up the share holders may lose a part or full of their
capital but he debenture holders invariably get back their investment
bull Investment in shares is riskier as it represents residual interest in the company
Debenture being debt is senior
bull Debentures are quite often secured that is a security interest is created on some
assets to back up debentures There is no question of any security in case of
shares
bull Share holders have a right to attend and vote at the meetings of the share holders
whereas debenture holders have no such rights
13
Quasi debt instruments
Preference shares
Preference shares are different from ordinary equity shares Preference share holders have
the following preferential rights
(i) The right to get a fixed rate of dividend before the payment of dividend to the equity
holders
(ii) The right to get back their capital before the equity holders in case of winding up of
the company
Eligibility norms for public issue ICDR Regulations
IPO
Conditions for IPO (all conditions listed below to be satisfied)
bull Net tangible assets of 3 crore in each of the preceding 3 full years of which not
more than 50 are held in monetary assets
bull Track record of distributable profits for 3 out of the immediately preceding 5
years
bull Net worth of 1 crore in each of the preceding three full years
bull Issue size of proposed issue + all previous issues made in the same financial year
does not exceed 5 times its pre-issue net worth as per the audited balance sheet of
the preceding financial year
bull In case of change of name within the last one year 50 of the revenue for the
preceding 1 full year earned by it from the activity indicated by the new name
14
If the issuer does not satisfy any of the condition listed above issuer may make IPO
by satisfying the following
1 Issue through book building
subject to allotment of 50 of net
offer to public to QIB failing
which full subscription monies to
be refunded
O
R
bull 15 of the cost of the project to
be contributed by SCB or PFI of
which not less than 10 from
the appraisers +
bull allotment of 10 of the net
offer to public to QIB failing
which full subscription monies
to be refunded
2 Minimum post-issue face value
capital of the issuer is 10 crores
O
R
Issuer to provide market-making for 2
yrs from the date of listing of the
specified securities
15
bull Promotersrsquo contribution
o Cannot be less than 20 of the post issue capital
o Maximum not defined but in view of the required minimum public offer as
per Rule 19 (2) (b) of Securities Contracts Regulations promoters
contribution plus any firm allotments cannot exceed 90 or 75 of the issue
size as the case may be (see below)
bull Minimum Public offer By public offer is meant the securities being offered to
public by advertisement exclusive of promotersrsquo contribution and firm allotments
o Rule 19(2)(b) of the Securities Contracts (Regulations) Rules 1957 requires
that the minimum public offer should be 25 of total issued securities should
be offered to public through advertisement
o However a lower public offer of 10 is allowed if the following conditions
are satisfied
1048707 The minimum public offer is Rs 100 crores and the number of
securities being offered to public is at least 20 lakh securities
1048707 The offer is made through mandatory book-building route with
minimum allocation of 60 to QIBs
bull Firm allotment reservations Subject to the minimum public offer norms issuers
are free to make reservations on competitive basis (as defined hereinafter) andor firm
allotments (as defined hereinafter) to various categories of persons for the remaining
part of the issue size
Firm allotment This implies allotment on a firm basis in public issues by an issuing
company Specified Categories for Firm allotment in public issues can be made to the
following
1 Indian and Multilateral Development Financial Institutions
16
2 Indian Mutual Funds
3 Foreign Institutional Investors (including non resident Indians and overseas
corporate bodies)
4 Permanent regular employees of the issuer company ndash maximum 10 of total
proposed issue amount
5 Scheduled Banks
6 Lead Merchant Banker- subject to a ceiling of 5 of the proposed issue
FPO
bull Promotersrsquo contribution
o In case of FPO the promoters should ensure participation either to the extent
of 20 of the proposed issue or their post-issue share holding must be to the
extent of 20 of the post issue capital Requirement to bring in contribution
from promoters shall be optional for a company listed on a stock exchange for
at least 3 years and having a track record of dividend payment of 3 years
immediately preceding the year of issue
o As for maximum promotersrsquo contribution Rule 19 (2) (b) stated above shall
be applicable
o Participation by promoters in excess of above shall be treated as preferential
allotment to which preferential allotment rules will be applicable As for
preferential allotment rules see Notes under sec 81
bull Net Public offer
o The minimum net public offer shall be as per Rule 19 (2) (b) ndash see above
17
bull Firm allotment reservations
o The issuer companies are free to make reservations on competitive basis (as
defined above) andor firm allotments to various categories of persons
enumerated above for the remaining issue size that is after considering
promotersrsquo contribution and public offer
o The reservation on competitive basis may also be made for retail individual
shareholders (RIS) For meaning of the term RIS see under lsquocategories of
investorsrsquo below
Composite Issue
bull Promotersrsquo contribution
o promoters have option to contribute either 20 of the proposed issue or 20
of post issue capital
o the right issue component to be excluded while computing the post-issue
capital
bull Others
o The right issue component to be offered to the existing shareholders
o Except the above the rules of allotment under IPO as above shall apply
Qualified Institutional Placement
Another class of issue not being a rights issue which calls for resolution under sec 81
(1A)
Condition for issue-
bull The equity shares of the same class were listed on a stock exchange having
nation-wide trading terminals for a period of at least one year as on the date of
issuance of notice for issue of shares to QIBs
bull The issue should not violate the prescribed minimum public shareholding
18
requirements specified by the listing agreement
Reservation
bull Minimum of 10 percent of specified securities issued shall be allotted to mutual
funds
bull In case the mutual funds do not agree to take shares issued under this chapter
such shares may be allotted to other QIBs
bull However no allotment shall be made under this chapter either directly or
indirectly to any QIB being a promoter or any person related to promoters
Withdrawal of bid not permitted- Investors shall not be allowed to withdraw their bids
after the closure of issue
Number of allottees-
bull minimum number of allottees shall not be less than
o Two where the issue size is less than or equal to Rs 250 crores
o Five where the issue size is greater than Rs 250 crores
bull No single allottee shall be allotted more than 50 of the issue size
Restrictions-
bull Amount raised through the proposed placement + all previous placements made in
the same financial year shall not exceed five times the net worth of the issuer as
per the audited balance sheet of the previous financial year
bull Lock-in-period of one year from the date of allotment except when sold on a
recognised stock exchange
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
11
called for a specified period of time
o Similar to the call option of the issuer there is a put option for the investor
to sell the securities back to the issuer at a predetermined price and date
The investor may do so anticipating rise in the interest rates wherein the
investor would liquidate the funds and alternatively invest in place of
higher interest
bull Refunding provisions ndash in case where the issuer may not have cash to redeem the
debt instruments the issuer may issue new debt instrument and use the proceeds to
repay the securities or to exercise the call option
Debt instruments may be of various kinds depending on the repayment
bull Bullet payment ndash instruments where the issuer agrees to repay the entire amount
at the maturity date ie lumpsum payment is called bullet payment
bull Sinking fund payment ndash instruments where the issuer agrees to retire a specified
portion of the debt each year is called sinking fund requirement
bull Amortization ndash instruments where there are scheduled principal repayments
before maturity date are called amortizing instruments
Debentures Bonds
The term Debenture is derived from the Latin word lsquodeberersquo which means lsquoto owe a
debtrsquo A debenture is an acknowledgment of debt taken either from the public or a
particular source A debenture may be viewed as a loan represented as marketable
security The word ldquobondrdquo may be used interchangeably with debentures
Debt instruments with maturity more than 5 years are called lsquobondsrsquo
Yields
Most common method of calculating the yields on debt instrument is the lsquoyield to
maturityrsquo method the formula is as under
12
Main differences between shares and debentures
bull Share money forms a part of the capital of the company The share holders are
part proprietors of the company whereas debentures are mere debt and debenture
holders are just creditors
bull Share holders get dividend only out of profits and in case of insufficient or no
profits they get nothing and debenture holders being creditors get guaranteed
interest as agreed whether the company makes profit or not
bull Share holders are paid after the debenture holders are paid their due first
bull The dividend on shares depends upon the profit of the company but the interest on
debentures is very well fixed at the time of issue itself
bull Shares are not to be paid back by the company whereas debentures have to be
paid back at the end of a fixed period
bull In case the company is wound up the share holders may lose a part or full of their
capital but he debenture holders invariably get back their investment
bull Investment in shares is riskier as it represents residual interest in the company
Debenture being debt is senior
bull Debentures are quite often secured that is a security interest is created on some
assets to back up debentures There is no question of any security in case of
shares
bull Share holders have a right to attend and vote at the meetings of the share holders
whereas debenture holders have no such rights
13
Quasi debt instruments
Preference shares
Preference shares are different from ordinary equity shares Preference share holders have
the following preferential rights
(i) The right to get a fixed rate of dividend before the payment of dividend to the equity
holders
(ii) The right to get back their capital before the equity holders in case of winding up of
the company
Eligibility norms for public issue ICDR Regulations
IPO
Conditions for IPO (all conditions listed below to be satisfied)
bull Net tangible assets of 3 crore in each of the preceding 3 full years of which not
more than 50 are held in monetary assets
bull Track record of distributable profits for 3 out of the immediately preceding 5
years
bull Net worth of 1 crore in each of the preceding three full years
bull Issue size of proposed issue + all previous issues made in the same financial year
does not exceed 5 times its pre-issue net worth as per the audited balance sheet of
the preceding financial year
bull In case of change of name within the last one year 50 of the revenue for the
preceding 1 full year earned by it from the activity indicated by the new name
14
If the issuer does not satisfy any of the condition listed above issuer may make IPO
by satisfying the following
1 Issue through book building
subject to allotment of 50 of net
offer to public to QIB failing
which full subscription monies to
be refunded
O
R
bull 15 of the cost of the project to
be contributed by SCB or PFI of
which not less than 10 from
the appraisers +
bull allotment of 10 of the net
offer to public to QIB failing
which full subscription monies
to be refunded
2 Minimum post-issue face value
capital of the issuer is 10 crores
O
R
Issuer to provide market-making for 2
yrs from the date of listing of the
specified securities
15
bull Promotersrsquo contribution
o Cannot be less than 20 of the post issue capital
o Maximum not defined but in view of the required minimum public offer as
per Rule 19 (2) (b) of Securities Contracts Regulations promoters
contribution plus any firm allotments cannot exceed 90 or 75 of the issue
size as the case may be (see below)
bull Minimum Public offer By public offer is meant the securities being offered to
public by advertisement exclusive of promotersrsquo contribution and firm allotments
o Rule 19(2)(b) of the Securities Contracts (Regulations) Rules 1957 requires
that the minimum public offer should be 25 of total issued securities should
be offered to public through advertisement
o However a lower public offer of 10 is allowed if the following conditions
are satisfied
1048707 The minimum public offer is Rs 100 crores and the number of
securities being offered to public is at least 20 lakh securities
1048707 The offer is made through mandatory book-building route with
minimum allocation of 60 to QIBs
bull Firm allotment reservations Subject to the minimum public offer norms issuers
are free to make reservations on competitive basis (as defined hereinafter) andor firm
allotments (as defined hereinafter) to various categories of persons for the remaining
part of the issue size
Firm allotment This implies allotment on a firm basis in public issues by an issuing
company Specified Categories for Firm allotment in public issues can be made to the
following
1 Indian and Multilateral Development Financial Institutions
16
2 Indian Mutual Funds
3 Foreign Institutional Investors (including non resident Indians and overseas
corporate bodies)
4 Permanent regular employees of the issuer company ndash maximum 10 of total
proposed issue amount
5 Scheduled Banks
6 Lead Merchant Banker- subject to a ceiling of 5 of the proposed issue
FPO
bull Promotersrsquo contribution
o In case of FPO the promoters should ensure participation either to the extent
of 20 of the proposed issue or their post-issue share holding must be to the
extent of 20 of the post issue capital Requirement to bring in contribution
from promoters shall be optional for a company listed on a stock exchange for
at least 3 years and having a track record of dividend payment of 3 years
immediately preceding the year of issue
o As for maximum promotersrsquo contribution Rule 19 (2) (b) stated above shall
be applicable
o Participation by promoters in excess of above shall be treated as preferential
allotment to which preferential allotment rules will be applicable As for
preferential allotment rules see Notes under sec 81
bull Net Public offer
o The minimum net public offer shall be as per Rule 19 (2) (b) ndash see above
17
bull Firm allotment reservations
o The issuer companies are free to make reservations on competitive basis (as
defined above) andor firm allotments to various categories of persons
enumerated above for the remaining issue size that is after considering
promotersrsquo contribution and public offer
o The reservation on competitive basis may also be made for retail individual
shareholders (RIS) For meaning of the term RIS see under lsquocategories of
investorsrsquo below
Composite Issue
bull Promotersrsquo contribution
o promoters have option to contribute either 20 of the proposed issue or 20
of post issue capital
o the right issue component to be excluded while computing the post-issue
capital
bull Others
o The right issue component to be offered to the existing shareholders
o Except the above the rules of allotment under IPO as above shall apply
Qualified Institutional Placement
Another class of issue not being a rights issue which calls for resolution under sec 81
(1A)
Condition for issue-
bull The equity shares of the same class were listed on a stock exchange having
nation-wide trading terminals for a period of at least one year as on the date of
issuance of notice for issue of shares to QIBs
bull The issue should not violate the prescribed minimum public shareholding
18
requirements specified by the listing agreement
Reservation
bull Minimum of 10 percent of specified securities issued shall be allotted to mutual
funds
bull In case the mutual funds do not agree to take shares issued under this chapter
such shares may be allotted to other QIBs
bull However no allotment shall be made under this chapter either directly or
indirectly to any QIB being a promoter or any person related to promoters
Withdrawal of bid not permitted- Investors shall not be allowed to withdraw their bids
after the closure of issue
Number of allottees-
bull minimum number of allottees shall not be less than
o Two where the issue size is less than or equal to Rs 250 crores
o Five where the issue size is greater than Rs 250 crores
bull No single allottee shall be allotted more than 50 of the issue size
Restrictions-
bull Amount raised through the proposed placement + all previous placements made in
the same financial year shall not exceed five times the net worth of the issuer as
per the audited balance sheet of the previous financial year
bull Lock-in-period of one year from the date of allotment except when sold on a
recognised stock exchange
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
12
Main differences between shares and debentures
bull Share money forms a part of the capital of the company The share holders are
part proprietors of the company whereas debentures are mere debt and debenture
holders are just creditors
bull Share holders get dividend only out of profits and in case of insufficient or no
profits they get nothing and debenture holders being creditors get guaranteed
interest as agreed whether the company makes profit or not
bull Share holders are paid after the debenture holders are paid their due first
bull The dividend on shares depends upon the profit of the company but the interest on
debentures is very well fixed at the time of issue itself
bull Shares are not to be paid back by the company whereas debentures have to be
paid back at the end of a fixed period
bull In case the company is wound up the share holders may lose a part or full of their
capital but he debenture holders invariably get back their investment
bull Investment in shares is riskier as it represents residual interest in the company
Debenture being debt is senior
bull Debentures are quite often secured that is a security interest is created on some
assets to back up debentures There is no question of any security in case of
shares
bull Share holders have a right to attend and vote at the meetings of the share holders
whereas debenture holders have no such rights
13
Quasi debt instruments
Preference shares
Preference shares are different from ordinary equity shares Preference share holders have
the following preferential rights
(i) The right to get a fixed rate of dividend before the payment of dividend to the equity
holders
(ii) The right to get back their capital before the equity holders in case of winding up of
the company
Eligibility norms for public issue ICDR Regulations
IPO
Conditions for IPO (all conditions listed below to be satisfied)
bull Net tangible assets of 3 crore in each of the preceding 3 full years of which not
more than 50 are held in monetary assets
bull Track record of distributable profits for 3 out of the immediately preceding 5
years
bull Net worth of 1 crore in each of the preceding three full years
bull Issue size of proposed issue + all previous issues made in the same financial year
does not exceed 5 times its pre-issue net worth as per the audited balance sheet of
the preceding financial year
bull In case of change of name within the last one year 50 of the revenue for the
preceding 1 full year earned by it from the activity indicated by the new name
14
If the issuer does not satisfy any of the condition listed above issuer may make IPO
by satisfying the following
1 Issue through book building
subject to allotment of 50 of net
offer to public to QIB failing
which full subscription monies to
be refunded
O
R
bull 15 of the cost of the project to
be contributed by SCB or PFI of
which not less than 10 from
the appraisers +
bull allotment of 10 of the net
offer to public to QIB failing
which full subscription monies
to be refunded
2 Minimum post-issue face value
capital of the issuer is 10 crores
O
R
Issuer to provide market-making for 2
yrs from the date of listing of the
specified securities
15
bull Promotersrsquo contribution
o Cannot be less than 20 of the post issue capital
o Maximum not defined but in view of the required minimum public offer as
per Rule 19 (2) (b) of Securities Contracts Regulations promoters
contribution plus any firm allotments cannot exceed 90 or 75 of the issue
size as the case may be (see below)
bull Minimum Public offer By public offer is meant the securities being offered to
public by advertisement exclusive of promotersrsquo contribution and firm allotments
o Rule 19(2)(b) of the Securities Contracts (Regulations) Rules 1957 requires
that the minimum public offer should be 25 of total issued securities should
be offered to public through advertisement
o However a lower public offer of 10 is allowed if the following conditions
are satisfied
1048707 The minimum public offer is Rs 100 crores and the number of
securities being offered to public is at least 20 lakh securities
1048707 The offer is made through mandatory book-building route with
minimum allocation of 60 to QIBs
bull Firm allotment reservations Subject to the minimum public offer norms issuers
are free to make reservations on competitive basis (as defined hereinafter) andor firm
allotments (as defined hereinafter) to various categories of persons for the remaining
part of the issue size
Firm allotment This implies allotment on a firm basis in public issues by an issuing
company Specified Categories for Firm allotment in public issues can be made to the
following
1 Indian and Multilateral Development Financial Institutions
16
2 Indian Mutual Funds
3 Foreign Institutional Investors (including non resident Indians and overseas
corporate bodies)
4 Permanent regular employees of the issuer company ndash maximum 10 of total
proposed issue amount
5 Scheduled Banks
6 Lead Merchant Banker- subject to a ceiling of 5 of the proposed issue
FPO
bull Promotersrsquo contribution
o In case of FPO the promoters should ensure participation either to the extent
of 20 of the proposed issue or their post-issue share holding must be to the
extent of 20 of the post issue capital Requirement to bring in contribution
from promoters shall be optional for a company listed on a stock exchange for
at least 3 years and having a track record of dividend payment of 3 years
immediately preceding the year of issue
o As for maximum promotersrsquo contribution Rule 19 (2) (b) stated above shall
be applicable
o Participation by promoters in excess of above shall be treated as preferential
allotment to which preferential allotment rules will be applicable As for
preferential allotment rules see Notes under sec 81
bull Net Public offer
o The minimum net public offer shall be as per Rule 19 (2) (b) ndash see above
17
bull Firm allotment reservations
o The issuer companies are free to make reservations on competitive basis (as
defined above) andor firm allotments to various categories of persons
enumerated above for the remaining issue size that is after considering
promotersrsquo contribution and public offer
o The reservation on competitive basis may also be made for retail individual
shareholders (RIS) For meaning of the term RIS see under lsquocategories of
investorsrsquo below
Composite Issue
bull Promotersrsquo contribution
o promoters have option to contribute either 20 of the proposed issue or 20
of post issue capital
o the right issue component to be excluded while computing the post-issue
capital
bull Others
o The right issue component to be offered to the existing shareholders
o Except the above the rules of allotment under IPO as above shall apply
Qualified Institutional Placement
Another class of issue not being a rights issue which calls for resolution under sec 81
(1A)
Condition for issue-
bull The equity shares of the same class were listed on a stock exchange having
nation-wide trading terminals for a period of at least one year as on the date of
issuance of notice for issue of shares to QIBs
bull The issue should not violate the prescribed minimum public shareholding
18
requirements specified by the listing agreement
Reservation
bull Minimum of 10 percent of specified securities issued shall be allotted to mutual
funds
bull In case the mutual funds do not agree to take shares issued under this chapter
such shares may be allotted to other QIBs
bull However no allotment shall be made under this chapter either directly or
indirectly to any QIB being a promoter or any person related to promoters
Withdrawal of bid not permitted- Investors shall not be allowed to withdraw their bids
after the closure of issue
Number of allottees-
bull minimum number of allottees shall not be less than
o Two where the issue size is less than or equal to Rs 250 crores
o Five where the issue size is greater than Rs 250 crores
bull No single allottee shall be allotted more than 50 of the issue size
Restrictions-
bull Amount raised through the proposed placement + all previous placements made in
the same financial year shall not exceed five times the net worth of the issuer as
per the audited balance sheet of the previous financial year
bull Lock-in-period of one year from the date of allotment except when sold on a
recognised stock exchange
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
13
Quasi debt instruments
Preference shares
Preference shares are different from ordinary equity shares Preference share holders have
the following preferential rights
(i) The right to get a fixed rate of dividend before the payment of dividend to the equity
holders
(ii) The right to get back their capital before the equity holders in case of winding up of
the company
Eligibility norms for public issue ICDR Regulations
IPO
Conditions for IPO (all conditions listed below to be satisfied)
bull Net tangible assets of 3 crore in each of the preceding 3 full years of which not
more than 50 are held in monetary assets
bull Track record of distributable profits for 3 out of the immediately preceding 5
years
bull Net worth of 1 crore in each of the preceding three full years
bull Issue size of proposed issue + all previous issues made in the same financial year
does not exceed 5 times its pre-issue net worth as per the audited balance sheet of
the preceding financial year
bull In case of change of name within the last one year 50 of the revenue for the
preceding 1 full year earned by it from the activity indicated by the new name
14
If the issuer does not satisfy any of the condition listed above issuer may make IPO
by satisfying the following
1 Issue through book building
subject to allotment of 50 of net
offer to public to QIB failing
which full subscription monies to
be refunded
O
R
bull 15 of the cost of the project to
be contributed by SCB or PFI of
which not less than 10 from
the appraisers +
bull allotment of 10 of the net
offer to public to QIB failing
which full subscription monies
to be refunded
2 Minimum post-issue face value
capital of the issuer is 10 crores
O
R
Issuer to provide market-making for 2
yrs from the date of listing of the
specified securities
15
bull Promotersrsquo contribution
o Cannot be less than 20 of the post issue capital
o Maximum not defined but in view of the required minimum public offer as
per Rule 19 (2) (b) of Securities Contracts Regulations promoters
contribution plus any firm allotments cannot exceed 90 or 75 of the issue
size as the case may be (see below)
bull Minimum Public offer By public offer is meant the securities being offered to
public by advertisement exclusive of promotersrsquo contribution and firm allotments
o Rule 19(2)(b) of the Securities Contracts (Regulations) Rules 1957 requires
that the minimum public offer should be 25 of total issued securities should
be offered to public through advertisement
o However a lower public offer of 10 is allowed if the following conditions
are satisfied
1048707 The minimum public offer is Rs 100 crores and the number of
securities being offered to public is at least 20 lakh securities
1048707 The offer is made through mandatory book-building route with
minimum allocation of 60 to QIBs
bull Firm allotment reservations Subject to the minimum public offer norms issuers
are free to make reservations on competitive basis (as defined hereinafter) andor firm
allotments (as defined hereinafter) to various categories of persons for the remaining
part of the issue size
Firm allotment This implies allotment on a firm basis in public issues by an issuing
company Specified Categories for Firm allotment in public issues can be made to the
following
1 Indian and Multilateral Development Financial Institutions
16
2 Indian Mutual Funds
3 Foreign Institutional Investors (including non resident Indians and overseas
corporate bodies)
4 Permanent regular employees of the issuer company ndash maximum 10 of total
proposed issue amount
5 Scheduled Banks
6 Lead Merchant Banker- subject to a ceiling of 5 of the proposed issue
FPO
bull Promotersrsquo contribution
o In case of FPO the promoters should ensure participation either to the extent
of 20 of the proposed issue or their post-issue share holding must be to the
extent of 20 of the post issue capital Requirement to bring in contribution
from promoters shall be optional for a company listed on a stock exchange for
at least 3 years and having a track record of dividend payment of 3 years
immediately preceding the year of issue
o As for maximum promotersrsquo contribution Rule 19 (2) (b) stated above shall
be applicable
o Participation by promoters in excess of above shall be treated as preferential
allotment to which preferential allotment rules will be applicable As for
preferential allotment rules see Notes under sec 81
bull Net Public offer
o The minimum net public offer shall be as per Rule 19 (2) (b) ndash see above
17
bull Firm allotment reservations
o The issuer companies are free to make reservations on competitive basis (as
defined above) andor firm allotments to various categories of persons
enumerated above for the remaining issue size that is after considering
promotersrsquo contribution and public offer
o The reservation on competitive basis may also be made for retail individual
shareholders (RIS) For meaning of the term RIS see under lsquocategories of
investorsrsquo below
Composite Issue
bull Promotersrsquo contribution
o promoters have option to contribute either 20 of the proposed issue or 20
of post issue capital
o the right issue component to be excluded while computing the post-issue
capital
bull Others
o The right issue component to be offered to the existing shareholders
o Except the above the rules of allotment under IPO as above shall apply
Qualified Institutional Placement
Another class of issue not being a rights issue which calls for resolution under sec 81
(1A)
Condition for issue-
bull The equity shares of the same class were listed on a stock exchange having
nation-wide trading terminals for a period of at least one year as on the date of
issuance of notice for issue of shares to QIBs
bull The issue should not violate the prescribed minimum public shareholding
18
requirements specified by the listing agreement
Reservation
bull Minimum of 10 percent of specified securities issued shall be allotted to mutual
funds
bull In case the mutual funds do not agree to take shares issued under this chapter
such shares may be allotted to other QIBs
bull However no allotment shall be made under this chapter either directly or
indirectly to any QIB being a promoter or any person related to promoters
Withdrawal of bid not permitted- Investors shall not be allowed to withdraw their bids
after the closure of issue
Number of allottees-
bull minimum number of allottees shall not be less than
o Two where the issue size is less than or equal to Rs 250 crores
o Five where the issue size is greater than Rs 250 crores
bull No single allottee shall be allotted more than 50 of the issue size
Restrictions-
bull Amount raised through the proposed placement + all previous placements made in
the same financial year shall not exceed five times the net worth of the issuer as
per the audited balance sheet of the previous financial year
bull Lock-in-period of one year from the date of allotment except when sold on a
recognised stock exchange
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
14
If the issuer does not satisfy any of the condition listed above issuer may make IPO
by satisfying the following
1 Issue through book building
subject to allotment of 50 of net
offer to public to QIB failing
which full subscription monies to
be refunded
O
R
bull 15 of the cost of the project to
be contributed by SCB or PFI of
which not less than 10 from
the appraisers +
bull allotment of 10 of the net
offer to public to QIB failing
which full subscription monies
to be refunded
2 Minimum post-issue face value
capital of the issuer is 10 crores
O
R
Issuer to provide market-making for 2
yrs from the date of listing of the
specified securities
15
bull Promotersrsquo contribution
o Cannot be less than 20 of the post issue capital
o Maximum not defined but in view of the required minimum public offer as
per Rule 19 (2) (b) of Securities Contracts Regulations promoters
contribution plus any firm allotments cannot exceed 90 or 75 of the issue
size as the case may be (see below)
bull Minimum Public offer By public offer is meant the securities being offered to
public by advertisement exclusive of promotersrsquo contribution and firm allotments
o Rule 19(2)(b) of the Securities Contracts (Regulations) Rules 1957 requires
that the minimum public offer should be 25 of total issued securities should
be offered to public through advertisement
o However a lower public offer of 10 is allowed if the following conditions
are satisfied
1048707 The minimum public offer is Rs 100 crores and the number of
securities being offered to public is at least 20 lakh securities
1048707 The offer is made through mandatory book-building route with
minimum allocation of 60 to QIBs
bull Firm allotment reservations Subject to the minimum public offer norms issuers
are free to make reservations on competitive basis (as defined hereinafter) andor firm
allotments (as defined hereinafter) to various categories of persons for the remaining
part of the issue size
Firm allotment This implies allotment on a firm basis in public issues by an issuing
company Specified Categories for Firm allotment in public issues can be made to the
following
1 Indian and Multilateral Development Financial Institutions
16
2 Indian Mutual Funds
3 Foreign Institutional Investors (including non resident Indians and overseas
corporate bodies)
4 Permanent regular employees of the issuer company ndash maximum 10 of total
proposed issue amount
5 Scheduled Banks
6 Lead Merchant Banker- subject to a ceiling of 5 of the proposed issue
FPO
bull Promotersrsquo contribution
o In case of FPO the promoters should ensure participation either to the extent
of 20 of the proposed issue or their post-issue share holding must be to the
extent of 20 of the post issue capital Requirement to bring in contribution
from promoters shall be optional for a company listed on a stock exchange for
at least 3 years and having a track record of dividend payment of 3 years
immediately preceding the year of issue
o As for maximum promotersrsquo contribution Rule 19 (2) (b) stated above shall
be applicable
o Participation by promoters in excess of above shall be treated as preferential
allotment to which preferential allotment rules will be applicable As for
preferential allotment rules see Notes under sec 81
bull Net Public offer
o The minimum net public offer shall be as per Rule 19 (2) (b) ndash see above
17
bull Firm allotment reservations
o The issuer companies are free to make reservations on competitive basis (as
defined above) andor firm allotments to various categories of persons
enumerated above for the remaining issue size that is after considering
promotersrsquo contribution and public offer
o The reservation on competitive basis may also be made for retail individual
shareholders (RIS) For meaning of the term RIS see under lsquocategories of
investorsrsquo below
Composite Issue
bull Promotersrsquo contribution
o promoters have option to contribute either 20 of the proposed issue or 20
of post issue capital
o the right issue component to be excluded while computing the post-issue
capital
bull Others
o The right issue component to be offered to the existing shareholders
o Except the above the rules of allotment under IPO as above shall apply
Qualified Institutional Placement
Another class of issue not being a rights issue which calls for resolution under sec 81
(1A)
Condition for issue-
bull The equity shares of the same class were listed on a stock exchange having
nation-wide trading terminals for a period of at least one year as on the date of
issuance of notice for issue of shares to QIBs
bull The issue should not violate the prescribed minimum public shareholding
18
requirements specified by the listing agreement
Reservation
bull Minimum of 10 percent of specified securities issued shall be allotted to mutual
funds
bull In case the mutual funds do not agree to take shares issued under this chapter
such shares may be allotted to other QIBs
bull However no allotment shall be made under this chapter either directly or
indirectly to any QIB being a promoter or any person related to promoters
Withdrawal of bid not permitted- Investors shall not be allowed to withdraw their bids
after the closure of issue
Number of allottees-
bull minimum number of allottees shall not be less than
o Two where the issue size is less than or equal to Rs 250 crores
o Five where the issue size is greater than Rs 250 crores
bull No single allottee shall be allotted more than 50 of the issue size
Restrictions-
bull Amount raised through the proposed placement + all previous placements made in
the same financial year shall not exceed five times the net worth of the issuer as
per the audited balance sheet of the previous financial year
bull Lock-in-period of one year from the date of allotment except when sold on a
recognised stock exchange
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
15
bull Promotersrsquo contribution
o Cannot be less than 20 of the post issue capital
o Maximum not defined but in view of the required minimum public offer as
per Rule 19 (2) (b) of Securities Contracts Regulations promoters
contribution plus any firm allotments cannot exceed 90 or 75 of the issue
size as the case may be (see below)
bull Minimum Public offer By public offer is meant the securities being offered to
public by advertisement exclusive of promotersrsquo contribution and firm allotments
o Rule 19(2)(b) of the Securities Contracts (Regulations) Rules 1957 requires
that the minimum public offer should be 25 of total issued securities should
be offered to public through advertisement
o However a lower public offer of 10 is allowed if the following conditions
are satisfied
1048707 The minimum public offer is Rs 100 crores and the number of
securities being offered to public is at least 20 lakh securities
1048707 The offer is made through mandatory book-building route with
minimum allocation of 60 to QIBs
bull Firm allotment reservations Subject to the minimum public offer norms issuers
are free to make reservations on competitive basis (as defined hereinafter) andor firm
allotments (as defined hereinafter) to various categories of persons for the remaining
part of the issue size
Firm allotment This implies allotment on a firm basis in public issues by an issuing
company Specified Categories for Firm allotment in public issues can be made to the
following
1 Indian and Multilateral Development Financial Institutions
16
2 Indian Mutual Funds
3 Foreign Institutional Investors (including non resident Indians and overseas
corporate bodies)
4 Permanent regular employees of the issuer company ndash maximum 10 of total
proposed issue amount
5 Scheduled Banks
6 Lead Merchant Banker- subject to a ceiling of 5 of the proposed issue
FPO
bull Promotersrsquo contribution
o In case of FPO the promoters should ensure participation either to the extent
of 20 of the proposed issue or their post-issue share holding must be to the
extent of 20 of the post issue capital Requirement to bring in contribution
from promoters shall be optional for a company listed on a stock exchange for
at least 3 years and having a track record of dividend payment of 3 years
immediately preceding the year of issue
o As for maximum promotersrsquo contribution Rule 19 (2) (b) stated above shall
be applicable
o Participation by promoters in excess of above shall be treated as preferential
allotment to which preferential allotment rules will be applicable As for
preferential allotment rules see Notes under sec 81
bull Net Public offer
o The minimum net public offer shall be as per Rule 19 (2) (b) ndash see above
17
bull Firm allotment reservations
o The issuer companies are free to make reservations on competitive basis (as
defined above) andor firm allotments to various categories of persons
enumerated above for the remaining issue size that is after considering
promotersrsquo contribution and public offer
o The reservation on competitive basis may also be made for retail individual
shareholders (RIS) For meaning of the term RIS see under lsquocategories of
investorsrsquo below
Composite Issue
bull Promotersrsquo contribution
o promoters have option to contribute either 20 of the proposed issue or 20
of post issue capital
o the right issue component to be excluded while computing the post-issue
capital
bull Others
o The right issue component to be offered to the existing shareholders
o Except the above the rules of allotment under IPO as above shall apply
Qualified Institutional Placement
Another class of issue not being a rights issue which calls for resolution under sec 81
(1A)
Condition for issue-
bull The equity shares of the same class were listed on a stock exchange having
nation-wide trading terminals for a period of at least one year as on the date of
issuance of notice for issue of shares to QIBs
bull The issue should not violate the prescribed minimum public shareholding
18
requirements specified by the listing agreement
Reservation
bull Minimum of 10 percent of specified securities issued shall be allotted to mutual
funds
bull In case the mutual funds do not agree to take shares issued under this chapter
such shares may be allotted to other QIBs
bull However no allotment shall be made under this chapter either directly or
indirectly to any QIB being a promoter or any person related to promoters
Withdrawal of bid not permitted- Investors shall not be allowed to withdraw their bids
after the closure of issue
Number of allottees-
bull minimum number of allottees shall not be less than
o Two where the issue size is less than or equal to Rs 250 crores
o Five where the issue size is greater than Rs 250 crores
bull No single allottee shall be allotted more than 50 of the issue size
Restrictions-
bull Amount raised through the proposed placement + all previous placements made in
the same financial year shall not exceed five times the net worth of the issuer as
per the audited balance sheet of the previous financial year
bull Lock-in-period of one year from the date of allotment except when sold on a
recognised stock exchange
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
16
2 Indian Mutual Funds
3 Foreign Institutional Investors (including non resident Indians and overseas
corporate bodies)
4 Permanent regular employees of the issuer company ndash maximum 10 of total
proposed issue amount
5 Scheduled Banks
6 Lead Merchant Banker- subject to a ceiling of 5 of the proposed issue
FPO
bull Promotersrsquo contribution
o In case of FPO the promoters should ensure participation either to the extent
of 20 of the proposed issue or their post-issue share holding must be to the
extent of 20 of the post issue capital Requirement to bring in contribution
from promoters shall be optional for a company listed on a stock exchange for
at least 3 years and having a track record of dividend payment of 3 years
immediately preceding the year of issue
o As for maximum promotersrsquo contribution Rule 19 (2) (b) stated above shall
be applicable
o Participation by promoters in excess of above shall be treated as preferential
allotment to which preferential allotment rules will be applicable As for
preferential allotment rules see Notes under sec 81
bull Net Public offer
o The minimum net public offer shall be as per Rule 19 (2) (b) ndash see above
17
bull Firm allotment reservations
o The issuer companies are free to make reservations on competitive basis (as
defined above) andor firm allotments to various categories of persons
enumerated above for the remaining issue size that is after considering
promotersrsquo contribution and public offer
o The reservation on competitive basis may also be made for retail individual
shareholders (RIS) For meaning of the term RIS see under lsquocategories of
investorsrsquo below
Composite Issue
bull Promotersrsquo contribution
o promoters have option to contribute either 20 of the proposed issue or 20
of post issue capital
o the right issue component to be excluded while computing the post-issue
capital
bull Others
o The right issue component to be offered to the existing shareholders
o Except the above the rules of allotment under IPO as above shall apply
Qualified Institutional Placement
Another class of issue not being a rights issue which calls for resolution under sec 81
(1A)
Condition for issue-
bull The equity shares of the same class were listed on a stock exchange having
nation-wide trading terminals for a period of at least one year as on the date of
issuance of notice for issue of shares to QIBs
bull The issue should not violate the prescribed minimum public shareholding
18
requirements specified by the listing agreement
Reservation
bull Minimum of 10 percent of specified securities issued shall be allotted to mutual
funds
bull In case the mutual funds do not agree to take shares issued under this chapter
such shares may be allotted to other QIBs
bull However no allotment shall be made under this chapter either directly or
indirectly to any QIB being a promoter or any person related to promoters
Withdrawal of bid not permitted- Investors shall not be allowed to withdraw their bids
after the closure of issue
Number of allottees-
bull minimum number of allottees shall not be less than
o Two where the issue size is less than or equal to Rs 250 crores
o Five where the issue size is greater than Rs 250 crores
bull No single allottee shall be allotted more than 50 of the issue size
Restrictions-
bull Amount raised through the proposed placement + all previous placements made in
the same financial year shall not exceed five times the net worth of the issuer as
per the audited balance sheet of the previous financial year
bull Lock-in-period of one year from the date of allotment except when sold on a
recognised stock exchange
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
17
bull Firm allotment reservations
o The issuer companies are free to make reservations on competitive basis (as
defined above) andor firm allotments to various categories of persons
enumerated above for the remaining issue size that is after considering
promotersrsquo contribution and public offer
o The reservation on competitive basis may also be made for retail individual
shareholders (RIS) For meaning of the term RIS see under lsquocategories of
investorsrsquo below
Composite Issue
bull Promotersrsquo contribution
o promoters have option to contribute either 20 of the proposed issue or 20
of post issue capital
o the right issue component to be excluded while computing the post-issue
capital
bull Others
o The right issue component to be offered to the existing shareholders
o Except the above the rules of allotment under IPO as above shall apply
Qualified Institutional Placement
Another class of issue not being a rights issue which calls for resolution under sec 81
(1A)
Condition for issue-
bull The equity shares of the same class were listed on a stock exchange having
nation-wide trading terminals for a period of at least one year as on the date of
issuance of notice for issue of shares to QIBs
bull The issue should not violate the prescribed minimum public shareholding
18
requirements specified by the listing agreement
Reservation
bull Minimum of 10 percent of specified securities issued shall be allotted to mutual
funds
bull In case the mutual funds do not agree to take shares issued under this chapter
such shares may be allotted to other QIBs
bull However no allotment shall be made under this chapter either directly or
indirectly to any QIB being a promoter or any person related to promoters
Withdrawal of bid not permitted- Investors shall not be allowed to withdraw their bids
after the closure of issue
Number of allottees-
bull minimum number of allottees shall not be less than
o Two where the issue size is less than or equal to Rs 250 crores
o Five where the issue size is greater than Rs 250 crores
bull No single allottee shall be allotted more than 50 of the issue size
Restrictions-
bull Amount raised through the proposed placement + all previous placements made in
the same financial year shall not exceed five times the net worth of the issuer as
per the audited balance sheet of the previous financial year
bull Lock-in-period of one year from the date of allotment except when sold on a
recognised stock exchange
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
18
requirements specified by the listing agreement
Reservation
bull Minimum of 10 percent of specified securities issued shall be allotted to mutual
funds
bull In case the mutual funds do not agree to take shares issued under this chapter
such shares may be allotted to other QIBs
bull However no allotment shall be made under this chapter either directly or
indirectly to any QIB being a promoter or any person related to promoters
Withdrawal of bid not permitted- Investors shall not be allowed to withdraw their bids
after the closure of issue
Number of allottees-
bull minimum number of allottees shall not be less than
o Two where the issue size is less than or equal to Rs 250 crores
o Five where the issue size is greater than Rs 250 crores
bull No single allottee shall be allotted more than 50 of the issue size
Restrictions-
bull Amount raised through the proposed placement + all previous placements made in
the same financial year shall not exceed five times the net worth of the issuer as
per the audited balance sheet of the previous financial year
bull Lock-in-period of one year from the date of allotment except when sold on a
recognised stock exchange
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
19
Investments by Non- resident Investors
Provisions about investments by non-residents non resident Indians overseas bodies
corporates and other foreign investors are made by the RBI in pursuance of FEMA
provisions An overview is as follows
Foreign investment is freely permitted in almost all sectors in India Under Foreign Direct
Investments (FDI) Scheme investments can be made by non-residents in the shares
convertible debentures of an Indian Company under two routes
bull Automatic Route and
bull Government Route
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
20
3Derivatives
What are derivatives A derivative picks a risk or volatility in a financial asset
transaction market rate or contingency and creates a product the value of which will
change as per changes in the underlying risk or volatility The idea is that someone may
either try to safeguard against such risk (hedging) or someone may take the risk or may
engage in a trade on the derivative based on the view that they want to execute The risk
that a derivative intends to trade is called underlying
A derivative is a financial instrument whose value depends on the values of basic
underlying variable In the sense derivatives is a financial instrument that offers return
based on the return of some other underlying asset ie the return is derived from another
instrument
The best way will be take examples of uncertainties and the derivatives that can be
structured around the same
bull Stock prices are uncertain - Lot of forwards options or futures contracts are based
on movements in prices of individual stocks or groups of stocks
bull Prices of commodities are uncertain - There are forwards futures and options on
commodities
bull Interest rates are uncertain - There are interest rate swaps and futures
bull Foreign exchange rates are uncertain - There are exchange rate derivatives
bull Weather is uncertain - There are weather derivatives and so on
Derivative products initially emerged as a hedging device against fluctuations in
commodity prices and commodity linked derivatives remained the sole form of such
products for almost three hundred years It was primarily used by the farmers to protect
themselves against fluctuations in the price of their crops From the time it was sown to
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
21
the time it was ready for harvest farmers would face price uncertainties Through the use
of simple derivative products it was possible for the farmers to partially or fully transfer
price risks by locking in asset prices
From hedging devices derivatives have grown as major trading tool Traders may
execute their views on various underlyings by going long or short on derivatives of
different types
Financial derivatives
Financial derivatives are financial instruments whose prices are derived from the prices
of other financial instruments Although financial derivatives have existed for a
considerable period of time they have become a major force in financial markets only
since the early 1970s In the class of equity derivatives futures and options on stock
indices have gained more popularity than on individual stocks especially among
institutional investors who are major users of index-linked derivatives
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use
DERIVATIVES PRODUCTS
Some significant derivatives that are of interest to us are depicted in the accompanying
graph
Major types of derivatives
Derivative contracts have several variants Depending upon the market in which
they are traded derivatives are classified as 1) exchange traded and 2) over the counter
The most common variants are forwards futures options and swaps
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
22
Forwards
A forward contract is a customized contract between two entities where
settlement takes place as a specific date in the future at todayrsquos predetermined price
Ex On 1st June X enters into an agreement to buy 50 bales of cotton for 1st
December at Rs1000 per bale from Y a cotton dealer It is a case of a forward contract
where X has to pay Rs50000 on 1st December to Y and Y has to supply 50 bales of
cotton
Options
Options are of two types ndash call and put Calls give the buyer the right but not the
obligation to buy a given quantity of the underlying asset at a given price on or before a
given future date Puts give the buyer the right but not the obligation to sell a given
quantity of the underlying asset at a given price on or before a given date
Warrants
Options generally have maturity period of three months majority of options that
are traded on exchanges have maximum maturity of nine months Longer-traded options
are called warrants and are generally traded over-the-counter
Leaps
The acronym LEAPS means Long-term Equity Anticipation Securities These are
options having a maturity of up to three years
Baskets
Basket Options are currency-protected options and its return-profile is based on
the average performance of a pre-set basket of underlying assets The basket can be
interest rate equity or commodity related A basket of options is made by purchasing
different options The payout is therefore the addition of each individual option payout
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
23
Swaps
Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula They can be regarded as portfolio of forward
contracts The two commonly used Swaps are
i) Interest Rate Swaps - A interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency
ii) Currency Swaps - A currency swap is a foreign exchange agreement between
two parties to exchange a given amount of one currency for another and after a
specified period of time to give back the original amount swapped
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
24
4FUTURES FORWARDS AND OPTIONS
An option is different from futures in several ways At practical level the option buyer
faces an interesting situation He pays for the options in full at the time it is purchased
After this he only has an upside There is no possibility of the options position
generating any further losses to him This is different from futures where one is free to
enter but can generate huge losses This characteristic makes options attractive to many
market participants who trade occasionally who cannot put in the time to closely monitor
their futures position
Buying put options is like buying insurance To buy a put option on Nifty is to buy
insurance which reimburses the full amount to which Nifty drops below the strike price
of the put option This is attractive to traders and to mutual funds creating ldquoguaranteed
return productsrdquo
FORWARDS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price
The other party assumes a short position and agrees to sell the asset on the same date for
the same price other contract details like delivery date price and quantity are negotiated
bilaterally by the parties to the contract The forward contracts are normally traded
outside the exchange
The salient features of forward contracts are
1048766 They are bilateral contracts and hence exposed to counter-party risk
1048766 Each contract is custom designed and hence is unique in terms of contract size
expiration date and the asset type and quality
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
25
1048766 The contract price is generally not available in public domain
1048766 On the expiration date the contract has to be settled by delivery of the asset or
net settlement
The forward markets face certain limitations such as
1048766 Lack of centralization of trading
1048766 Illiquidity and
1048766 Counterparty risk
FUTURES
Contract is a standardized transaction taking place on the futures
exchange Futures market was designed to solve the problems that exist in forward
market A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price but unlike forward contracts the futures
contracts are standardized and exchange traded To facilitate liquidity in the futures
contracts the exchange specifies certain standard quantity and quality of the underlying
instrument that can be delivered and a standard time for such a settlement Futuresrsquo
exchange has a division or subsidiary called a clearing house that performs the specific
responsibilities of paying and collecting daily gains and losses as well as guaranteeing
performance of one party to other A futures contract can be offset prior to maturity by
entering into an equal and opposite transaction More than 99 of futures transactions are
offset this way
Yet another feature is that in a futures contract gains and losses on each partyrsquos position
is credited or charged on a daily basis this process is called daily settlement or marking
to market Any person entering into a futures contract assumes a long or short position
by a small amount to the clearing house called the margin money
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
26
The standardized items in a futures contract are
1048766 Quantity of the underlying
1048766 Quality of the underlying
1048766 The date and month of delivery
1048766 The units of price quotation and minimum price change
1048766 Location of settlement
FUTURES TERMINOLOGY
1 SPOT PRICE The price at which an asset trades in the spot market
2 FUTURES PRICE The price at which the futures contract trades in the futures
market
3 CONTRACT CYCLE The period over which a contract trades The index futures
contracts on the NSE have one month two months and three months expiry cycles
that expires on the last Thursday of the month Thus a contract which is to expire
in January will expire on the last Thursday of January
4 EXPIRY DATE It is the date specified in the futures contract This is the last day
on which the contract will be traded at the end of which it will cease to exist
5 CONTRACT SIZE It is the quantity of asset that has to be delivered under one
contract For instance the contract size on NSErsquos futures market is 200 Nifties
6 BASIS In the context of financial futures basis can be defined as the futures
price minus the spot price There will be different basis for each delivery month
for each contract In a normal market basis will be positive this reflects that the
futures price exceeds the spot prices
7 COST OF CARRY The relationship between futures price and spot price can be
summarized in terms of what is known as the cost of carry
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
27
8 INITIAL MARGIN The amount that must be deposited in the margin account at
the time when a futures contract is first entered into is known as initial margin
9 MARK TO MARKET In the futures market at the end of each trading day the
margin account is adjusted to reflect the investorrsquos gain or loss depending upon
the futures closing price This is called Marking-to-market
10 MAINTENANCE MARGIN This is somewhat lower than the initial margin
This is set to ensure that the balance in the margin account never becomes
negative If the balance in the margin account falls below the maintenance
margin the investor receives a margin call and is expected to top up the margin
account to the initial margin level before trading commences on the next day
Stock futures contract
It is a contractual agreement to trade in stock shares of a company on a future date Some
of the basic things in a futures trade as specified by the exchange are
bull Contract size
bull Expiration cycle
bull Trading hours
bull Last trading day
bull Margin requirement
Advantages of stock futures trading
bull Investing in futures is less costly as there is only initial margin money to be
deposited
bull A large array of strategies can be used to hedge and speculate with smaller cash
outlay there is greater liquidity
Disadvantages of stock futures trading
bull The risk of losses is greater than the initial investment of margin money
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
28
bull The futures contract does not give ownership or voting rights in the equity in
which it is trading
bull There is greater vigilance required because futures trades are marked to market
daily
INDEX DERIVATIVES
Index derivatives are derivative contracts that has index as the underlying The
most popular index derivatives contract is index futures and index options NSErsquos market
index - the SampP CNX Nifty are examples of exchange traded index futures
An index is a broad-based weighted average of prices of selected constituents that
form part of the index The rules for construction of the index are defined by the body
that creates the index Trading in stock index futures was first introduced by the Kansas
City Board of Trade in 1982
Advantages of investing in stock index futures
bull Diversification of the risks as the investor is not investing in a particular stock
bull Flexibility of changing the portfolio and adjusting the exposures to particular
stock index market or industry
OPTIONS
An option is a contract or a provision of a contract that gives one party (the
option holder) the right but not the obligation to perform a specified transaction with
another party (the option issuer or option writer) according to the specified terms The
owner of a property might sell another party an option to purchase the property any time
during the next three months at a specified price For every buyer of an option there must
be a seller The seller is often referred to as the writer As with futures options are
brought into existence by being traded if none is traded none exists conversely there is
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
29
no limit to the number of option contracts that can be in existence at any time As with
futures the process of closing out options positions will cause contracts to cease to exist
diminishing the total number
Thus an option is the right to buy or sell a specified amount of a financial
instrument at a pre-arranged price on or before a particular date
There are two options which can be exercised
1048766 Call option the right to buy is referred to as a call option
1048766 Put option the right to sell is referred as a put option
OPTION TERMINOLOGY
1 INDEX OPTION These options have the index as the underlying Some
options are European while others are American European style options
can be exercised only on the maturity date of the option which is known
as the expiry date An American style option can be exercised at any time
upto and including the expiry date It is to be noted that the distinction
has nothing to do with geography Both type of the option are traded all
over the world
2 STOCK OPTION Stock options are options on individual stocks A
contract gives the holder the right to buy or sell shares at the specified
price
3 BUYER OF AN OPTION The buyer of an option is the one who by
paying the option premium buys the right but not the obligation to exercise
the options on the sellerwriter
4 WRITER OF AN OPTION The writer of a callput option is the one who
receives the option premium and is thereby obliged to sellbuy the asset if
the buyer exercised on him
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
30
5 STRIKE PRICE The price specified in the option contract is known as the
strike price or the exercise price
6 lsquoIN THE MONEYrsquo OPTION An lsquoin the moneyrsquo option is an option that
would lead to a positive cash flow to the holder if it was exercised
immediately A call option on the index is said to be in-the-money (ITM)
when the current index stands at a level higher than the strike price (ie
spot pricegt strike price) If the index is much higher than the strike price
the call is said to be deep ITM In the case of a put the put is ITM if the
index is below the strike price
7 lsquoAT THE MONEYrsquo OPTION An lsquoat the moneyrsquo option is an option that
would lead to zero cash flow to the holder if it were exercised
immediately An option on the index is at the money when the current
index equals the strike price(ie spot price = strike price)
8 lsquoOUT OF THE MONEYrsquo OPTION An lsquoout of the moneyrsquo(OTM) option
is an option that would lead to a negative cash flow for the holder if it
were exercised immediately A call option on the index is out of the
money when the current index stands at a level lower than the strike
price(ie spot price lt strike price) If the index is much lower than the
strike price the call is said to be deep OTM In the case of a put the put is
OTM if the index is above the strike price
9 INTRINSIC VALUE OF AN OPTION The option premium can be
broken down into two components - intrinsic value and time value The
intrinsic value of a call is the ITM value of the option that is if the call is
OTM its intrinsic value will be zero
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
31
10 TIME VALUE OF AN OPTION The time value of an option is the
difference between its premium and its intrinsic value Usually maximum
time value exists when the option is ATM The longer the time to
expiration the greater is an optionrsquos time value or else equal At
expiration an option should have no time value
Factors affecting value of options ndash you would understand this while using the
valuation techniques but the terms are introduced below
bull Price ndash value of the call option is directly proportionate to the change in the price
of the underlying Say for example
bull Time ndash as options expire in future time has an effect on the value of the options
bull Interest rates and Volatility ndash in case where the underlying asset is a bond or
interest rate interest rate volatility would have an impact on the option prices
The statistical or historical volatility (SV) helps measure the past price
movements of the stock and helps in understanding the future volatility of the
stock during the life of the option
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
32
5Commodity Derivatives
Commodity Derivatives are the first of the derivatives contracts that emerged to hedge
against the risk of the value of the agricultural crops going below the cost of production
Chicago Board of Trade was the first organized exchange established in 1848 to have
started trading in various commodities Chicago Board of Trade and Chicago Mercantile
Exchange are the largest commodities exchanges in the world
It is important to understand the attributes necessary in a commodity derivative contract
a) Commodity should have a high shelf life ndash only if the commodity has storability
durability will the carriers of the stock feel the need for hedging against the price
risks or price fluctuations involved
b) Units should be homogenous ndash the underlying commodity as defined in the
commodity derivative contract should be the same as traded in the cash market to
facilitate actual delivery in the cash market Thus the units of the commodity
should be homogenous
c) Wide and frequent fluctuations in the commodity prices ndash if the price fluctuations
in the cash market are small people would feel less incentivised to hedge or
insure against the price fluctuations and derivatives market would be of no
significance Also if by the inherent attributes of the cash market of the
commodity the cash market of the commodity was such that it would eliminate
the risks of volatility or price fluctuations derivatives market would be of no
significance Taking an oversimplified example if an investor had purchased 100
tons of rice Rs 10 kg in the cash market and is of the view that the prices may
fall in the future he may short a rice future at Rs 10 kg to hedge against the fall
in prices Now if the prices fall to Rs 2 kg the loss that the investor makes in
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
33
the cash market may be compensated by squaring of the short position thus
eliminating the risk of price fluctuations in the commodity market
Commodity derivative contracts are standardized contracts and are traded as per the
investors needs The needs of the investor may be instrumental or convenience
depending upon the needs the investor would trade in a derivative product Instrumental
risks would relate to price risk reduction and convenience needs would relate to
flexibility in trade or efficient clearing process
Commodity Derivatives in India
Commodity derivatives in India were established by the Cotton Trade Association in
1875 since then the market has suffered from liquidity problems and several regulatory
dogmas However in the recent times the commodity trade has grown significantly and
today there are 25 derivatives exchanges in India which include four national commodity
exchanges National Commodity and Derivatives Exchange (NCDEX) National MultiCommodity
Exchange of India (NCME) National Board of Trade (NBOT) and Multi
Commodity Exchange (MCX)
NCDEX
It is the largest commodity derivatives exchange in India and is the only commodity
exchange promoted by national level institutions NCDEX was incorporated in 2003
under the Companies Act 1956 and is regulated by the Forward Market Commission in
respect of the futures trading in commodities NCDEX is located in Mumbai
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
34
MCX
MCX is recognised by the government of India and is amongst the worldrsquos top three
bullion exchanges and top four energy exchanges MCXrsquos headquarter is in Mumbai and
facilitates online trading clearing and settlement operations for the commodoties futures
market in the country
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
35
6Bonds
What Are Bonds
A bond is a debt security similar to an IOU When you purchase a bond you are lending money to a government municipality corporation federal agency 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 comes due
Among the types of bonds you can choose from in Uganda are government securities and corporate bonds
Many personal financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds stocks and cash in varying percentages depending upon individual circumstances and objectives 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 Whatever the purpose saving for your childrenrsquos college education or a new home increasing retirement income or any of a number of other financial goals investing in bonds can help you achieve your objectives
InterestRateBonds 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 UShs 1000000 bond with an 8 interest rate will pay investors UShs 80000 a year in payments of UShs 40000 every six months When the bond matures investors receive the full face amount of the bond UShs 1000000
But 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 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 UShs 2000000 maturing in 20 years might be purchased for about UShs 5050000 At the end of the 20 years the investor will receive UShs 20000000 The difference between UShs 20000000 and UShs 5050000 represents the interest based on an interest rate of 7 which compounds automatically until the bond matures
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
36
MaturityA bonds maturity refers to the specific future date on which the investors principal will be repaid Bond maturities generally range from one day up to 30 years In some cases bonds have been issued for terms of up to 100 years Maturity ranges are often categorized as follows
Short-term notes maturities of up to five years Intermediate notesbonds maturities of five to 12 years Long-term bonds maturities of 12 or more years
Redemption Features
While the maturity period is a good guide as to how long the bond will be outstanding certain bonds have structures that can substantially change the expected life of the investment
Call Provisions
For example some bonds have redemption or all 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 Before you buy a bond always ask if there is a call provision and if there is be sure to obtain the yield to call as well as the yield to maturity Bonds with a redemption provision usually have a higher annual return to compensate for the risk that the bonds might be called early
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
Principal Payments and Average Life
In addition mortgage backed securities are typically priced and traded on the basis of their average life rather than their stated maturity When mortgage rates decline homeowners often prepay mortgages which may result in an earlier than expected return of principal to an investor This may reduce the average life of the investment If mortgage rates rise the reverse may be true homeowners will be slow to prepay and investors may find their principal committed longer than expected
Your choice of maturity will depend on when you want or need the principal repaid and the kind of investment you are seeking within your risk tolerance Some individuals might choose short term bonds for their comparative stability and safety although their investment returns will typically be lower than would be the case with long term securities Alternatively investors
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
37
seeking greater overall returns might be more interested in long term securities despite the fact that their value is more vulnerable to interest rate fluctuations and other market risks as well as credit risk
Yield
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 Current yield is the annual return on the amount paid for the bond and is derived by dividing the bonds interest payment by its purchase price If you bought at UShs 1000000 and the interest rate is 8 (UShs 80000) the current yield is 8 (UShs 80000 divide UShs 1000000) If you bought at UShs 900000 and the interest rate is 8 (UShs 80000) the current yield is 889 (UShs 80000 divide UShs 900000)
Yield to maturity and yield to call which are considered more meaningful tell you the total return you will receive by holding the bond until it matures or is called It also enables you to compare bonds with different maturities and coupons Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield) plus any gain (if you purchased the bond below its par or face value) or loss (if you purchased it above its par value) Yield to call is calculated the same way as yield to maturity but assumes that a bond will be called and that the investor will receive face value back at the call date You should ask your investment advisor for the yield to maturity or yield to call on any bond you are considering purchasing Buying a bond based only on current yield may not be sufficient since it may not represent the bonds real value to your portfolio
Market Fluctuations
Price and Yield from the time a bond is originally issued until the day it matures its price in the marketplace will fluctuate according to changes in market conditions or credit quality The constant fluctuation in price is true of individual bonds and true of the entire bond market with every change in the level of interest rates typically having an immediate and predictable effect on the prices of bonds
The Link Between Interest Rates and Maturity
Changes in interest rates dont 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 It can best be seen by drawing a line between the yields available on like securities of different maturities from shortest to longest Such a line is called a yield curve
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
38
7Share
What is a Share
A share (or stock) is a stake in a company When you buy a share you become a part owner or a shareholder of the company
What are the different types of shares
Ordinary shares (also known as equity shares) - these are shares or stocks that give the shareholder part ownership of the company in proportion to the number of shares held The ordinary shareholders have voting rights and can appoint and dismiss directors If the company makes a profit they are entitled to a share of it in the form of dividends if declared which are based on proportionate ownership In the event of liquidation ordinary shareholders are paid last after everyone else who has a claim on the companys assets has been paid
Preference shares- Preference shares bear a fixed annual rate of dividend with priority over all ordinary shares in the distribution of dividends from annual profits and have a prior claim to repayment on winding up the company Shareholders in this category have no voting rights in a company but are given priority with regard to dividends and repayment in the event of winding up
Redeemable Preference shares- These are shares that can be redeemed (paid back to the shareholder) by the company either at fixed dates and prices or on certain specified terms at the discretion of the Board of Directors
Advantages of owning sharesAs a shareholder there are several advantages that come with owning shares These include
Dividends When a company makes a profit the Board of Directors usually gives a percentage of the profit to its shareholders This is known as a dividend In other cases the directors can propose to retain the profits in the company in order to increase its capital These are known as retained earnings Ideally if profits increase from year to year then the dividend should also increase Shares therefore offer the possibility of an increasing income to the investor
Capital growth If the company is growing the value of the shares will also grow Capital Gains When shares are sold at a price that is higher than the price at which they
were purchased this represents a profit This profit is called a capital gain Voting rights Shares give a shareholder the right to attend and vote on important
company policies at the companys Annual General Meetings including making a choice on the directors of the company
Collateral Shares may be accepted as collateral (for example security for a loan) Transferability Shares are negotiable and can be passed on to another person and they
can be inherited
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
39
Disadvantages of owning sharesMuch as there are good things associated with owning shares there are some considerations that need to be taken on board these include
Share prices can go down or up depending on a number of factors such as the performance of the company the economy demand and supply factors
If the companys profits fall the dividend will fall and if the company makes a loss it may not be able to pay any dividend
If the share prices fall their value lessens and if the company collapses or becomes insolvent the shares become worthless
If the company goes into liquidation shareholders are the last to be paid after all other creditors
Primary market- this refers to the purchase of shares in an Initial Public Offering (IPO) whereby a company offers its shares to members of the public for the first time To buy these shares a Share Application Form (SAF) is obtained from participating brokerdealers and authorised selling agents which is completed by the prospective investor
The Share Application Form (SAF) is then sent to the Lead Broker and Registrar for processing where the share allocation is made Once payment is made a receipt is issued to the purchaser
If the offer is over-subscribed (applications exceeding the number of shares available) the shares available are divided among applicants according to the allotment criteria and the investor then receives a refund for the shares paid for but not allocated
The USE then deposits shares on the Securities Central Depository accounts of successful applicants
Secondary market- At the secondary market shares can only be bought or sold through a licensed brokerdealer that is a firm that buys and sells securities on behalf of investors for a commission or a brokerage fee
The brokerdealer or investment advisor will provide all the necessary advice that is which shares to buy But the ultimate decision to invest your money is up to you the investor Before investing in shares you should be clear about your own financial position and what you hope to achieve from your investment
To sell shares an investor needs to contact a brokerdealer and instruct himher to sell either all or some of your shares
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
40
8Collective Investment Schemes
What are Collective Investment Schemes
Collective Investment Schemes (CISs) are private financial arrangements They pool resources of many small savers generating a large pool The resources are then invested in various assets like shares bonds property and treasury bills with the sole purpose of generating high returns while minimizing risk through diversification of investments
Collective Investment Schemes (CISs) provide a means for mobilisation of savings and enable small investors to participate in capital markets CISs widen the choice of investment vehicles involve the public in the process of investing in securities through pooling resources together which are then invested by professional managers
Types of CISs
There are currently two types of schemes in Uganda
1 Unit Trust Schemes These are types of schemes where investors buy units which represent the various holdings of the scheme
Ones investment is represented by the units they hold in the scheme The Unit Trust Scheme is established by a trust deed between a fund manager (which must be a body corporate) and a trustee (bank or insurance company) The trust deed spells out the duties and obligations of the fund manager and trustee In a unit trust investments are made on behalf of the unit holders by the unit trust manager but the assets of the scheme are held by the trustee or custodian
The manager purchases the investors unit at the ruling price and the investors money is desposited onto hisher bank account within two days
The main duties of a fund manager include
Marketing the fund Appointing a fund manager to manage investors funds Provide liquidity to the unit holders who wish to sell their investments
The functions of the trustee include the following
Overseeing of the fund Safeguarding the assets of the scheme Ensuring that the fund manager manages the fund according to the trust deed
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
41
Why invest in unit trusts
It gives you an opportunity to liquidate investments by selling your units back to the manager
Minimises risk by diversifying investments A chance to reap more benefits because of the expertise of proffessional staff Investors can access high-priced markets because of the pooled resources which create a
larger fund
Who Manages CISsThe investments are selected and managed by professionals known as fund managers in the case of Unit Trusts Investors are therefore not involved in the day to day decisions concerning how their money is invested
The investors pay a fixed percentage of the return to the fund manager The scheme therefore makes money by managing other peoples money Investment income and capital gains generated by the scheme are passed on to the investors and are shared in proportion to the investors holding in the CIS
Advantages of Collective Investment SchemesThe attraction of CISs in developed countries has been attributed to five main factors risk access to securities investments cost professional management and regulation
Diversification of Risk- Investors can secure a much wider diversification of risk because these funds usually invest in different investments Studies show that the greater the diversification of a portfolio the lower the risk in relation to the return Those who invest in CISs are therefore seeking to lower risks in relation to their returns
Access to Securities Investments - By investing a small sum (either in a lump sum or on a regular saving basis) an investor through the CIS can achieve a personal portfolio spread over several securities
Lower Transaction Costs- By investing in a CIS investors incur lower costs than if they were to buy and sell a portfolio of individual securities directly This is because transaction costs are generally related to the size of the transaction and investors benefit from the fund managers ability to deal in larger quantities of shares at lower average dealing costs Fund managers can also reallocate portfolios more efficiently than can individual investors
Professional Management- Due to the complexity of analyzing information regarding individual securities most individuals do not have the professional skills to manage their own investments CISs provide full time professional management in a direct and simple form and this is especially important where market information is not widely available
Investor protection- CISs have succeeded in developed markets due to an effective legal and regulatory framework People need to have confidence that their money is protected from fraud theft and other abuses The CIS Act and regulations made under it provide the desired regulatory framework that will protect investors
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
42
Terms Commonly used in Collective Investment SchemesInvestment advisor A person who provides advice in relation to the company giving the advantages of investment opportunities or information that assists a potential investor to make an investment decision
Fund ManagerIs a person licensed by the Authority to undertake on behalf of the client the management of a portfolio of funds
UnitTrustsA unit trust is an investment scheme that pools savings of the public who share the same financial interests The pooled savings are then invested in securities such as shares bonds and other authorised securities
TrusteeIndividual or company who holds the assets of a collective investment fund on behalf of its investors who are the beneficiaries of the trust
PortfolioFunds managed on behalf of clients at the discretion of a fund manager
Trust DeedAgreement between a Fund Manager and an Authorised Corporate Director (ACD)
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
43
9Debenture
In corporate finance a debenture is a medium- to long-term debt instrument used by large companies to borrow money at a fixed rate of interest The legal term debenture originally referred to a document that either creates a debt or acknowledges it but in some countries the term is now used interchangeably with bond loan stock or note A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure it does not become share capital Senior debentures get paid before subordinate debentures and there are varying rates of risk and payoff for these categories
Debentures are generally freely transferable by the debenture holder Debenture holders have no rights to vote in the companys general meetings of shareholders but they may have separate meetings or votes eg on changes to the rights attached to the debentures The interest paid to them is a charge against profit in the companys financial statements
Attributes
A movable property Issued by the company in the form of a certificate of indebtedness It generally specifies the date of redemption repayment of principal and interest on
specified dates May or may not create a charge on the assets of the company Corporations in the US often issue bonds of around $1000 while government bonds are
more likely to be $5000
Debentures gave rise to the idea of the rich clipping their coupons which means that a bondholder will present their coupon to the bank and receive a payment each quarter (or in whatever period is specified in the agreement)
There are also other features that minimize risk such as a sinking fund which means that the debtor must pay some of the value of the bond after a specified period of time This decreases risk for the creditors as a hedge against inflation bankruptcy or other risk factors A sinking fund makes the bond less risky and therefore gives it a smaller coupon (or interest payment) There are also options for convertibility which means a creditor may turn their bonds into equity in the company if it does well Companies also reserve the right to call their bonds which mean they can call it sooner than the maturity date Often there is a clause in the contract that allows this for example if a bond issuer wishes to rebuy a 30-year bond at the 25th year they must pay a premium If a bond is called it means that less interest is paid out
Failure to pay a bond effectively means bankruptcy Bondholders who have not received their interest can throw an offending company into bankruptcy or seize its assets if that is stipulated in the contract
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
44
10Security in different jurisdictions
In the United States debenture refers specifically to an unsecured corporate bond[2] ie a bond that does not have a certain line of income or piece of property or equipment to guarantee repayment of principal upon the bonds maturity Where security is provided for loan stocks or bonds in the US they are termed mortgage bonds
However in the United Kingdom a debenture is usually secured
In Canada a debenture refers to a secured loan instrument where security is generally over the debtors credit but security is not pledged to specific assets Like other secured debts the debenture gives the debtor priority status over unsecured creditors in a bankruptcy however debt instruments where security is pledged to specific assets (such as a bond) receive a higher priority status in a bankruptcy than do debentures
In Asia if repayment is secured by a charge over land the loan document is called a mortgage where repayment is secured by a charge against other assets of the company the document is called a debenture and where no security is involved the document is called a note or unsecured deposit note
Convertibility
There are two types of debentures
1 Convertible debentures which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time Convertibility is a feature that corporations may add to the bonds they issue to make them more attractive to buyers In other words it is a special feature that a corporate bond may carry As a result of the advantage a buyer gets from the ability to convert convertible bonds typically have lower interest rates than non-convertible corporate bonds
2 Non-convertible debentures which are simply regular debentures cannot be converted into equity shares of the liable company They are debentures without the convertibility feature attached to them As a result they usually carry higher interest rates than their convertible counterparts
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
45
11Conclusion
Running a successful Mutual Fund requires complete understanding of thepeculiarities of the Indian Stock Market and also the psyche of the small investors Thisstudy has made an attempt to understand the financial behavior of Mutual Fund investorsin connection with the preferences of Brand (AMC) Products Channels etc I observedthat many of people have fear of Mutual Fund They think their money will not be securein Mutual Fund They need the knowledge of Mutual Fund and its related terms Many ofpeople do not have invested in mutual fund due to lack of awareness although they havemoney to invest As the awareness and income is growing the number of mutual fundinvestors are also growingldquoBrandrdquo plays important role for the investment People invest in those Companieswhere they have faith or they are well known with them There are many AMCs in Punjabbut only some are performing well due to Brand awareness Some AMCs are notperforming well although some of the schemes of them are giving good return because ofnot awareness about BrandDistribution channels are also important for the investment in mutual fundFinancial Advisors are the most preferred channel for the investment in mutual fund Theycan change investorsrsquo mind from one investment option to others Many of investorsdirectly invest their money through AMC because they do not have to pay entry load Onlythose people invest directly who know well about mutual fund and its operations and thosehave time
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
46
12BIBLIOGRAPHY
middot NEWS PAPERS
middot OUTLOOK MONEY
middot TELEVISION CHANNEL (CNBC AAWAJ)
middot MUTUAL FUND HAND BOOK
middot FACT SHEET AND STATEMENT
middot WWWSBIMFCOM
middot WWWMONEYCONTROLCOM
middot WWWAMFIINDIACOM
middot WWWONLINERESEARCHONLINECOM
middot WWW MUTUALFUNDSINDIACOM
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
47
- SECURTY IN DIFFERENT JURISDICTIONS
- Attributes
- 10Security in different jurisdictions
- Convertibility
-
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