Financial InstrumentsGroup 5Ankit Saklani, 13P125Ashima Tayal, 13P130Jain Himanshu Hemant, 13P143Kaushik Trilok Nihalani, 13P148Rattanpreet Singh, 13P161Shashank Shukla, 13P166Financial InstrumentA financial instrument is a tradableassetof any kind; either cash, evidence of an ownership interest in an entity, or a contractual right to receive or deliver cash or another financial instrument.

History of FIs in IndiaFinancial Instruments (1/2)Long Term Financial InstrumentsPost Office Savings: Post Office Monthly Income Scheme is a low risk saving instrument, which can be availed through any post office. It provides an interest rate of around 8% per annum, which is paid monthlyPublic Provident Fund: A long term savings instrument with a maturity of 15 years and interest payable at 8% per annum compounded annually. Tax benefits can be availed for the amount invested and interest accrued is tax-freeCompany Fixed Deposits: These are short-term (6 months) to medium-term (3-5 years) borrowings by companies at a fixed rate of interest which is payable monthly, quarterly, semiannually or annually. The rate of interest varies between 6-9% per annum for company FDs. The interest received is after deduction of taxesBonds is generally a promise to repay the principal along with a fixed rate of interest on a specified date, called the Maturity Date. It is a fixed income (debt) instrument issued for a period of more than one year with the purpose of raising capitalMutual Funds: These are funds operated by an investment company which raises money from the public and invests in a group of assets. Benefits include professional money management, buying in small amounts and diversificationEquities are a type of security that represents the ownership in a company. Investing in equities is a good long-term investment option as the returns on equities over a long time horizon are generally higher than most other investment avenues. However, along with the possibility of greater returns comes greater risk.Financial Instruments (2/2)Short Term Financial InstrumentsSavings Bank Account is often the first banking product people use, which offers low interest (4%-5% p.a.), making them only marginally better than fixed deposits.Money Market or Liquid Funds are a specialized form of mutual funds that invest in extremely short-term fixed income instruments and thereby provide easy liquidity. Unlike most mutual funds, money market funds are primarily oriented towards protecting your capital and then, aim to maximize returnsFixed Deposits with banks are for investors with low risk appetite, and may be considered for 6-12 months investment period as normally interest on less than 6 months bank FDs is likely to be lower than money market fund returnsRepresent ownership in a firm and include:Common Stock: A residual claim on firms assets. Its dividends are paid only after interest are paid to debt holders and preferred stockholdersPreferred Stock: An equity with schedule dividends that typically do not change over securitys life.Warrants: Give bondholder an additional opportunity for returns when included with bonds. Give holder a right to buy firms common share at given price over a period of time Equity SecuritiesAre promises to repay borrowed money in futureDifferent type of debt securities are bonds, notes commercial papers, bills, certificate of deposits Bonds: Promise to make a series of interest payment in fixed amounts and to repay principal amount in maturity. Are generally long termThere are several terms related to bond:Maturity: Date on which principal is to be repaidPar Value: Principal amountCoupon Rate: Rate at which interest is paidSovereign Bond: Issued by National governments or their treasuries backed by taxing power, considered free from default riskNon Sovereign Government Bonds: Issued by state, provinces, countries or sometimes by entities created to fund services such as hospitals, airports Agency or Quasi Government Bonds: Issued by agencies created by national governmentSupranational Bonds: Issued by supranational agencies also known as multilateral agencies. Examples: IMF, World Bank, Asian Development Bank Debt SecuritiesType of BondsA forward contract is a customized contract between two parties, where settlement takes place on a specific date in future at a price agreed todayUnique in terms of contract size, expiration date and the asset type and quality and exposed to counter party riskThe contract price is generally not available in public domainHas to be settled by delivery of the asset on expiration dateIn case the party wishes to reverse the contract, it has to compulsorily go to the same counter party, which being in a monopoly situation can command the price it wantsCreated by dealers and are generally traded over the counterParty that agrees to buy the asset has a long forward position and is called a long and other party has a short forward position and is called short Forward ContractFuturesFutures are exchange-traded contracts to sell or buy financial instruments or physical commodities for a future delivery at an agreed priceThey are standardized as to amount, asset characteristics and delivery timeClearinghouse is the counter party too all future contracts. Each exchange has a clearing house which guarantees that traders in futures market will honor their obligationGovernment regulates the future marketFuture contracts require a margin money which is to be deposited by both long and shortSerial NoBasisFuturesForwards1NatureTraded on organized exchangeOver the Counter2Contract TermsStandardizedCustomised3LiquidityMore liquidLess liquid4Margin PaymentsRequires margin paymentsNot required5SettlementFollows daily settlementAt the end of the period6Squaring offCan be reversed with any member of the ExchangeContract can be reversed only with the same counter-party with whom it was entered intoDifference between Forwards and futuresAn option contract gives its owner the right but not the legal obligation to conduct a transaction involving an underlying asset at a predetermined future date and at a predetermine priceOption give option buyer the right to decide whether the trade will eventually take place or notThe seller of the option has obligation to perform if buyer exercises the optionCall option give buyer the right 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 to sell a given quantity of the underlying asset at a given price on or before a given dateOptionsSwapsAre agreements for exchange of one security for another to change the maturity (bonds), quality of issues (stocks or bonds), or because investment objectives have changedRecently, swaps have grown to include currency and interest rate swaps Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currencyCurrency swaps: These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction

Financial MarketsA financial market is a place where buyers and sellers come together to exchange a financial asset or a financial instrumentThey play an important role in all the stages of life of an FI, i.e., issuance, pre-trade, trade, post-trade and asset servicingExamples: Stock markets, Bond Markets, Money Markets, Forex MarketsPrimary MarketSecondary MarketADR/GDRIntroductionBenefitsDR TransactionBuyingSellingThe sale can take place in the secondary market, or the ordinary shares held outside the market can be released into the home trading market through a cross-border transactionThe sale can take place in the secondary market, or the ordinary shares held outside the market can be released into the home trading market through a cross-border transactionDR ClassificationSPONSORED are issued by one depositary bank appointed by an issuer company under a service contract called a deposit agreement. Sponsored DRs give an issuer input and control over the facility, and may allow the issuer the flexibility to list on a U.S. stock exchange, and to raise capital

UNSPONSORED DRs are issued by one or more depositary banks in response to market demand for a particular security without a formal agreement with a non-U.S. companySPONSORED LEVEL I DR Program is the simplest way for non-U.S. companies to access U.S. capital markets. Level I DRs are traded in the U.S. through OTC Markets with prices reported to the U.S. Financial Industry Regulatory Authority (FINRA), which makes such information publicly available through sources such as Bloomberg, Reuters, and OTC Markets

SPONSORED LEVEL II AND SPONSORED LEVEL III DRs: Companies that wish to list their DRs on a U.S. stock exchange, to raise capital or to make a U.S. acquisition using DRs, establish sponsored Level II or Level III DR programs. These DR programs require SEC registration, disclosure and reporting. The companies must also meet the listing requirements of the applicable stock exchanges. Level III DR is the term used for a company raising capital by issuing DRs

PRIVATE PLACEMENT AND OFFSHORE DRs: a non-U.S. company can also access the U.S. and other capital markets through SEC Rule 144A and/or SEC Regulation S DR facilities without SEC registration. Rule 144A programs provide for raising capital through the private placement of DRs with qualified institutional buyers in the United States

ADR Regulatory FrameworkFCCBForeign Currency Convertible bonds-issued in currencies different from the issuing company's domestic currencyForeign Currency Convertible bonds-Mix between debt and equity instrumentsIt retain all features of aconvertible bond, making it very attractive to both the investors and the issuers.Investors receive the safety of guaranteed payments on the bond and are also able to take advantage of any large price appreciation in the company's stock

Benefits to InvestorsThere is a safety of guaranteed payments on the bondIt assured a fixed return and capital protectionIt can take advantage of any large price appreciation in the companys stockIt provides investment opportunities in emerging marketsIt cab be redeemed at maturity if not convertedIt is easily marketable as investors enjoys option of conversion in to equity if resulting to capital appreciationGives the ability to access investment capital available in foreign marketsIt can be used to break into foreign marketsThe bond acts like both a debt and equity instrument. Like bonds it makes regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stockIt can be raised within a month while pure debt takes longer to raise

Benefits to IssuerExchange risk is more in FCCBs as interest on bond would be payable in foreign currency. FCCBs means creation of more debt and a FOREX outgo in terms of interest which is in foreign exchangeIn case of convertible bond the interest rate is low (around 3 to 4%) but there is exchange risk on interest as well as principal if the bonds are not converted in to equityIf the stock price plummets, investors will not go for conversion but redemption. So, companies have to refinance to fulfill the redemption promise which can hit earningsIt will remain as debt in the balance sheet until conversion

DisadvantagesFCCB RegulationsFCCBs can be accessed through automatic and approval route. Major regulators governing the FCCBs in India are Exchange Control Department of RBI and FCCB Division in Department of Economic Affairs at Ministry of Finance.Thank You