Capital Market

Instruments
Lecture Outline
Capital Market meaning
Capital Market Instruments -
Equity shares
Preference share
Non voting shares
Convertible Cumulative Debentures(CCD)
Fixed Deposits
Warrants
Debentures and Bonds
ADR and GDR
Capital Market
Capital market deals with medium term and long term funds. Its
focus is on financing of fixed investment
Main participants in capital market are mutual funds, insurance
organization, foreign institutional investors, corporates and
individuals
The capital/securities market has two segments :
i. Primary/new issue market and
ii. Secondary market/stock exchange(s)/market(s)
Primary/new issue market
It is that market in which shares, debentures and other securities are sold
for the first time for collecting long-term capital.
In the primary market, securities are offered to the public for subscription
for the purpose of raising capital or fund.

Features of Primary Market
It Is Related With New Issues
It Has No Particular Place
It Has Various Methods Of Float Capital: Following are the methods of
raising capital in the primary market:
i) Public Issue
ii) Offer For Sale
iii) Private Placement
iv) Right Issue
v) Electronic-Initial Public Offer

Secondary market/stock
exchange(s)/market(s)
Market for old/existing securities
It plays an indirect role in industrial financing by providing
liquidity to investment already made
The SE three vital function for the orderly growth of capital
formation are
1. Nexus between saving and investment
2. Liquidity to investors by offering place of transaction in
securities
3. continuous price formation.
Capital Market Instruments -
The capital market generally consists of the following long term period i.e., more than one year period,
financial instruments;
In the equity segment -
Equity shares,
preference shares,
convertible preference shares,
non-convertible preference shares etc and
In the debt segment
debentures,
zero coupon bonds,
deep discount bonds etc.

Hybrid Instruments have both the features of equity and debenture. This kind of
instruments is called as hybrid instruments. Examples are convertible debentures,
warrants etc.

Equity Shares
Equity shares represents ownership capital and its owner
ordinary shareholders/equity holders share the reward and risk
associated with ownership of the corporate enterprises.
Authorized equity/share capital represents the maximum amount
that a company can raise from the ordinary shares
Ordinary/Equity shares typically have par/face value in terms of
the price of each share. The most popular denomination being
Rs.10

Equity shares also known as Ordinary shares.
Equity shares represent the ownership position in a company. The
shareholders of equity shares are the legal owner of the company.
Equity shares are the source of the permanent capital since they
do not have a maturity date.
shareholders are entitled for dividend.
The amount or rate of dividend is not fixed: the companys board
of directors decides it.
An ordinary share is known as variable income security

Authorized Share Capital represents the maximum amount of
capital, which a company can raise from shareholders. The
portion of the authorized share capital, which has been offered
to shareholders, is called Issued Share Capital.
Subscribed Share Capital represents that part of the issued
share capital, which has been accepted by shareholders. The
amount of subscribed share capital actually paid up by
shareholders to the company is called Paid-Up Share Capital.
The companys earnings, which have not been distributed to
shareholders and have been retained in the business, are called
Reserves and Surplus.


1. Maturity: Equity shares provide permanent capital to the
company and cannot be redeemed during the life time
of the company

2. Claims on Income: Equity shareholders have a residual claim
on the income of a company. They have a claim on income
left after paying dividend to preference shareholders.

Features of Equity Shares
3. Claim on Assets: Ordinary shareholders have a residual claim on the
companys assets in the case of liquidation.

4. Right to control: Ordinary shareholders have the legal power to elect
directors on the board. Ordinary shareholders are able to control
management of the company through their voting rights and right to
maintain proportionate ownership.

5. Voting rights: Ordinary shareholders are required to vote for
election of directors and change in the memorandum of
association.

An ordinary share holder has votes equal to the number of
shares held by him.

Shareholders may vote in person or by proxy. A proxy gives a
designated person right to vote on behalf of a shareholder at the
companys annual general meeting.
6. Pre-emptive Right: The law grants shareholders the right to
purchase new shares in the same proportion as their current
ownership.

7. Limited Liability: Ordinary shareholders are the true owners of
the company, but their liability is limited to the amount of their
investment in shares.

Advantages of equity shares

Advantages to company:

1. Long-term and Permanent Capital
2. No Fixed Burden on the company's resources
3. Credit worthiness
4. Risk Capital
5. Dividend Policy




Advantages to Investors:

1. More Income
2. Right to Participate in the Control and Management
3. Capital profits
4. An Attraction of Persons having Limited Income

Disadvantages of equity shares

Disadvantages to company

1. Dilution in control
2. Trading on equity not possible
3. Over-capitalization
4. No flexibility in capital structure
5. High cost
6. Speculation


Disadvantages to investors

1. Uncertain and Irregular Income
2. Capital loss During Depression Period
3. Loss on Liquidation




A rights issue is a way in which a company can sell new
shares in order to raise capital. The law in India requires that
the new ordinary shares must be first issued to the existing
share holder.
RIGHT ISSUE OF EQUITY SHARES
Advantages of Right Issue
1. It gives existing shareholders securities called "rights", which give
the shareholders the right to purchase new shares at a discount to
the market price.

2. Issue involves less flotation cost as the company can avoid the
underwriting commission.

3. In the case of profitable companies, the issue is more likely to be
successful since the subscription price is set much below the
current market price.

Disadvantages
Share holders who fail to exercise their rights may lose in
terms of decline in their wealth.
The value of each share will be diluted as a result of the
increased number of shares issued.
Another disadvantage is for those companies whose share
holding is concentrated in the hands of financial institutions,
because of the conversion of loan into equity. They would
prefer public issue of shares rather than the right issue.



Preference Shares
It is a unique type of long term capital market instrument. It
combines some features of equity shares as well as some of
debentures
it carries a fixed rate of dividend
ranks higher than equity as a claimant to the income/assets
normally does not have a voting right
dividend paid out are not taxable
payment of dividend depend upon discretion of management
irredeemable preference shares have no fixed maturity date

Cont. .
Preference shares are a long term source of finance for a company.
They are neither completely similar to equity nor equivalent to debt.
The law treats them as shares but they have elements of both equity
shares and debt.

For this reason, they are also called hybrid financing instruments.
These are also known as preferred stock, preferred shares, or only
preferred in different part of the world.


Features of Preference Shares
1. Fixed Dividends Preference shares have fixed dividends. Also
preference dividends are not tax deductible.

2. Preference over Equity Preference share dividend has to be
paid before any dividend payment to ordinary equity shares & at
the time of liquidation also, these shares would be paid before
equity shares.

3. No Share in Earnings Preference shareholders can not claim on
the residual earnings and residual assets.

4. Fixed Maturity - Like debt, preference shares also have fixed
maturity date.

5. Cumulative dividend - It requires that all past unpaid
preference dividend be paid before any ordinary dividends are
paid.

6. Dividend from PAT - Preference share dividend is paid out of the
profits left after all expenses and even taxes.


Advantages of Preference Shares
Advantages from Company point of view

1. Fixed Return
2. No Voting Right
3. Flexibility in Capital Structure
4. No Charge on Assets
5. Widens Capital Market

Advantages from Investors point of view:

1. Regular Fixed Income
2. Preferential Rights
3. Voting Right for Safety of Interest
4. Lesser Capital Losses
5. Fair Security


Disadvantages of Preference Shares
Disadvantages for companies

1. Higher Rate of Dividend
2. Financial Burden
3. Dilution of Claim over Assets
4. Adverse effect on credit-worthiness
5. Tax disadvantage


Disadvantages for Investors

1. No Voting Right
2. Fixed Income
3. No claim over surplus
4. No Guarantee of Assets


Classification of Preference Share
1.Cumulative and Non-cumulative Preference shares
In the case of Cumulative preference shares, dividend in
arrears for the years in which company earned no profits or
insufficient profits receives the dividend in the year in which
company earns profits.
But, If company does not have any profits in a year, no dividend
will be paid to non-cumulative preference shareholders.
2. Redeemable and Irredeemable Preference Shares
Redeemable preference shares can be redeemed on or after a fixed
period after giving a proper notice of redemption to preference
shareholders. while Irredeemable preference shares are those shares
which cannot be redeemed during the lifetime of the company.

3.Convertible and Non-convertible preference shares
Preference shareholders are given a right to covert their holding into
ordinary shares such shares are known as convertible preference
shares. The holders of non-convertible preference shares have no such
right of conversion.



4. Participating and Non-participating Preference Shares
The holders of participating preference shares have a right to
participate in the surplus profits of the company remained after
paying dividend to the ordinary & preference shareholders at a fixed
rate. The preference shares which do not have such right to
participate in surplus profits, are known as non-participating
preference shares.



DEBENTURES
A debenture or a bond is long-term promissory note for raising
loan capital. The firm promises to pay interest and principal as
stipulated.
The purchaser of debenture is called lender or debenture-holder.
Although the money raised by the debentures becomes a part of
the company's capital structure, it does not become share capital.
Features of Debentures
1.Interest rate: The interest rate on a debenture is fixed and
known. Debenture interest is tax deductible.

2.Maturity: Debentures are issued for a specific period of time.

3.Redemption: Debentures are mostly redeemable, they are
generally redeemed on maturity.
4. Sinking fund: A sinking fund is cash set aside periodically for retiring
debentures. Periodic retirement of debt through sinking fund reduces the
amount required to redeem the remaining debt at maturity.

5. Buy-back (call) provision: Buy-back provisions enable the company to
redeem debenture at a specified price before the maturity date. Buy-back
price may be more than par value.
6. Indenture or debenture trust deed: An indenture is a legal
agreement between the company issuing debentures and the debenture
trustee who represents the debenture holders. Trustee ensures that the
company will fulfill the contractual obligations.

7. Security: Debentures are either secured or unsecured. A secured
debenture is secured by a lien on the companys specific assets. When
debentures are not protected by any security, they are known as
unsecured debenture.

8. Yield
The yield is related to its market price; Two types of yield:
The current yield on a debenture is the ratio of the annual interest
payment to the debentures market price.

The yield-to-maturity takes into account the payments of interest and
principal, over the life of the debenture.

9. Claims on assets and income
Debenture holders have a claim on the companys earning, prior to that
of the shareholders.


Types of Debentures
1. Non-convertible debentures (NCDs): NCDs are pure debentures
without a feature of conversion. They are repayable on maturity. The
investor is entitled for interest and repayment of principal.

2. Fully-convertible debentures (FCDs): FCDs are converted into shares
as per the terms of the issue, with regard to the price and time of
conversion.

3. Partly-convertible debenture (PCDs): The investor has advantages of
both convertible and non-convertible debenture blended into single
debenture.


Advantages of Debentures

1. Less costly
2. No ownership dilution
3. Fixed payment of interest
4. Reduced real obligation

Disadvantages of Debenture

1. Obligatory payments
2. Financial risk
3. Cash outflows
4. Restricted covenants
Non Voting Shares
Non-voting shares is shares that provides the shareholder very
little or no vote on corporate matters, such as election of the
board of directors or mergers.

This type of share is usually implemented for individuals who want
to invest in the companys profitability and success at the expense
of voting rights in the direction of the company. Preference shares
typically has nonvoting qualities.
Debentures
Debenture/bonds represents creditor ship securities and
debenture holders are ling-term creditors to the company
As a secured instrument, it is a promise to pay interest and repay
principal at stipulated times.
Types of Debentures:
Debentures are divided into different categories on the basis of:
(1)convertibility of the instrument
(2) Security
Convertibility
Debentures can be classified on the basis of convertibility into:
A. Non Convertible Debentures (NCD)
B. Partly Convertible Debentures (PCD)
C. Fully convertible Debentures (FCD)
D. Optionally Convertible Debentures (OCD)
CLASSIFICATION OF DEBEBTURES
From security point of view
On the basis of redemption
On the basis of Negotiability
On the basis of convertibility
On the basis of priority
From coupon or interest rate point of view

TYPES OF DEBEBTURES
From security point of view
Secured or Mortgage debentures
Unsecured debentures
On the basis of redemption
Redeemable debentures
Non-redeemable debentures
On the basis of Negotiability
Registered debentures
Bearer debentures
On the basis of convertibility
Convertible debentures
Non-convertible debentures

On the basis of priority
First debentures
Second debentures

From coupon or interest rate point of view
Coupon rate point
Zero coupon Rate


TYPES OF DEBEBTURES
From security point of view
Secured or Mortgage debentures
secured by a charge on the assets of the company.
debenture holders have the right to recover their principal
amount with the unpaid amount of interest on such debentures
out of the assets mortgaged by the company.

Unsecured debentures
such debentures do not carry any security with regard to the
principal amount or unpaid interest.

TYPES OF DEBEBTURES
On the basis of redemption
Redeemable debentures
debentures are issued for a fixed period.
principal amount of such debentures is paid off to the debenture holders on the
expiry of such period.
such debentures can be redeemed by annual drawings or by purchasing from the
open market.

Non-redeemable debentures
debentures which are not redeemed in the life time of the company.
such debentures are paid back only when the company goes into liquidation.

TYPES OF DEBEBTURES
On the basis of Negotiability
Registered debentures
debentures that are registered with the company.
amount of such debentures is payable only to those debenture holders whose
name appears in the register of the company.

Bearer debentures
debentures which are not recorded in a register of the company.
such debentures are transferrable merely by delivery.
holder of these debentures is entitled to get the interest.
TYPES OF DEBEBTURES
On the basis of convertibility
Convertible debentures
debentures that can be converted into shares of the company on
the expiry of pre-decided period.
the term and conditions of conversion are generally announced at
the time of issue of debentures.

Non-convertible debentures
debentures that can not be converted into shares of the
company.
TYPES OF DEBEBTURES
On the basis of priority
First debentures
debentures are redeemed before other debentures.

Second debentures
debentures are redeemed after the redemption of first
debentures.
TYPES OF DEBEBTURES
From coupon rate or interest rate point of view
Coupon rate point
Usually debentures are issued with a coupon rate, that is annual
interest rate on the face value of debentures.
This rate may be fixed or floating with the market interest rate.

Zero coupon rate
Such debentures does not carry coupon rate or specified interest
rate with itself.
These debentures are issued with substantial discount to
compensate the investor for interest.
Bonds
Bond is a debt security, in which the authorized issuer owes the
holders a debt and, depending on the terms of the bond, is
obliged to pay interest (the coupon) to use and/or to repay the
principal at a later date, termed maturity.
A bond is a formal contract to repay borrowed money with interest
at fixed intervals (ex semi annual, annual, sometimes monthly).
Fixed Deposits
The deposit placed by investors with companies for a fixed term
carrying a prescribed rate of interest is called Company Fixed
Deposit.
Financial institutions and Non-Banking Finance Companies (NBFCs)
also accept such deposits.
Deposits thus mobilized are governed by the Companies Act under
Section 58A.
These deposits are unsecured, i.e., if the company defaults, the
investor cannot sell the documents to recover his capital, thus
making them a risky investment option.
Warrants
A warrant entitles its holder to subscribe to the equity capital of
the company during a specified period at a
stated/particular/certain price. The holder acquires only right
(option) but he has no obligation to acquire the equity shares.

Warrants are generally issued in conjunction with/tied to other
instrument.
Depositary Receipts (DR)
Type of negotiable (transferable) financial security.
Traded on a local stock exchange.
Physical certificate allowing investors to hold shares in equity of other
countries.
Benefits
For the Company
1. Raise capital from foreign markets.
2. Increases the share liquidity.

For the I nvestor
1. Investors gain the benefits of diversification.
2. Investors will be able to reap the benefits of foreign (emerging) markets.
Parties to a Depository Receipt
brokers
depositary
Custodian



Issuer
Investment
banker
lawyers
Accountants
American Depository Receipt (ADR)
The first ADR was introduced by J.P. Morgan in 1927 for the British
retailer Selfridges.

Shares of many non-US companies trade on US stock exchanges.

ADRs are denominated and pay dividends in US dollars and may be traded
like regular shares of stock.

Types of ADR programs
Unsponsored Programme
Sponsored Level 1 ADRs (OTC Facility)
Sponsored Level II ADRs ("Listing" facility)
Sponsored Level III ADRs ("offering" facility)
Restricted Programs
Privately placed (SEC Rule 144A) ADRs
Offshore (SEC Regulation S) ADRs
WORKING OF ADR MARKET
Sponsored ADR program
INVES
TOR
US
EXCH
ANGE
BROK
E/
DEALE
R
3 LEVELS OF SPONSORED PROGRAMS
Under the sponsored program there are 3 levels and they are ;

Level 1- Level 1 depositary receipts are the lowest level of
sponsored ADRs that can be issued. When a company issues
sponsored ADRs, it has one designated depositary who also acts
as its transfer agent.

Level 1 shares can only be traded on the OTC market and the
company has minimal reporting requirements with the U.S.
Securities and Exchange Commission [SEC]

Level 2 depositary receipt programs are more complicated for a
foreign company. When a foreign company wants to set up a
Level 2 program, it must file a registration statement with the
U.S. SEC and is under SEC regulation.

The advantage that the company has by upgrading their
program to Level 2 is that the shares can be listed on a U.S.
stock exchange. These exchanges include the New York Stock
Exchange (NYSE), NASDAQ, and the American Stock Exchange
(AMEX).

A Level 3 American Depositary Receipt program is the highest
level a foreign company can sponsor. Because of this distinction,
the company is required to adhere to stricter rules that are
similar to those followed by U.S. companies.

Foreign companies with Level 3 programs will often issue
materials that are more informative and are more
accommodating to their U.S. shareholders because they rely on
them for capital
Unsponsored Programme:



Unsponsored shares trade on the over-the-
counter (OTC) market

Unsponsored ADRs are often issued by more than one
depositary bank


Restricted Programme


Foreign companies that want their stock to be
limited to being traded by only certain individuals
may set up a restricted program

ADR programs operating under one of these 2 rules
make up approximately 30% of all issued ADRs



Privately placed (SEC Rule 144A) ADRs


ADR program under SEC Rule 144A

private placement

restricted stock and may only be issued to or traded
by Qualified Institutional Buyers (QIBs)
Offshore (SEC Regulation S) ADRs


SEC Regulation S

Shares are not, and will not be registered with any United
States securities regulation authority

The shares are registered and issued to offshore, non-US
residents
GLOBAL DEPOSITORY
RECEIPTS
Global Depository Receipt
(GDR)
Certificate issued by a depository bank, which purchases shares of foreign
companies.

Several international banks issue GDRs, such as JPMorgan Chase,
Citigroup, Deutsche Bank, Bank of New York.

GDRs are often listed in the Frankfurt Stock Exchange, Luxembourg Stock
Exchange and in the London Stock Exchange.
Process
Co/- deposits
large no of shares
located in country
where it wants to
list.
The bank then
issues receipts
underlying the
shares (2-4)
Behaves exactly
like regular
stocks- price
fluctuation
according to
demand & supply
Is receipts are
sold to people of
that country
This receipt is
then listed on
local stock
exchanges.