CAPITAL MARKET INSTRUMENTS

A capital market is a market for securities (debt or equity), where business enterprises and government
can raise long-term funds. It is defined as a market in which money is provided for periods longer than a
year, as the raising of short-term funds takes place on other markets (e.g., the money market). The
capital market is characterized by a large variety of financial instruments: equity and preference shares,
fully convertible debentures (FCDs), non-convertible debentures (NCDs) and partly convertible
debentures (PCDs) currently dominate the capital market, however new instruments are being
introduced such as debentures bundled with warrants, participating preference shares, zero-coupon
bonds, secured premium notes, etc.

[Link] PREMIUM NOTES SPN: is a secured debenture redeemable at premium issued along with a
detachable warrant, redeemable after a notice period, say four to seven years. The warrants attached to
SPN gives the holder the right to apply and get allotted equity shares; provided the SPN is fully paid.
There is a lock-in period for SPN during which no interest will be paid for an invested amount. The SPN
holder has an option to sell back the SPN to the company at par value after the lock in period. If the
holder exercises this option, no interest/ premium will be paid on redemption. In case the SPN holder
holds it further, the holder will be repaid the principal amount along with the additional amount of
interest/ premium on redemption in installments as decided by the company. The conversion of
detachable warrants into equity shares will have to be done within the time limit notified by the
company.

2. DEEP DISCOUNT BONDS : A bond that sells at a significant discount from par value and has no coupon
rate or lower coupon rate than the prevailing rates of fixed-income securities with a similar risk profile.
They are designed to meet the long term funds requirements of the issuer and investors who are not
looking for immediate return and can be sold with a long maturity of 25-30 years at a deep discount on
the face value of debentures.

3. EQUITY SHARES WITH DETACHABLE WARRANTS: A warrant is a security issued by company entitling
the holder to buy a given number of shares of stock at a stipulated price during a specified period. These
warrants are separately registered with the stock exchanges and traded separately. Warrants are
frequently attached to bonds or preferred stock as a sweetener, allowing the issuer to pay lower interest
rates or dividends.

[Link] CONVERTIBLE DEBENTURES WITH INTEREST: This is a debt instrument that is fully converted
over a specified period into equity shares. The conversion can be in one or several phases. When the
instrument is a pure debt instrument, interest is paid to the investor. After conversion, interest
payments cease on the portion that converted. If project finance is raised through an FCD issue, the
investor can earn interest even when the project is under implementation. Once the project is
operational, the investor can participate in the profits through share price appreciation and dividend
payments

[Link] : They are fully convertible cumulative preference shares. This instrument is divided into 2
parts namely Part A & Part B. Part A is convertible into equity shares automatically /compulsorily on
date of allotment without any application by the allottee.
Part B is redeemed at par or converted into equity after a lock in period at the option of the investor, at
a price 30% lower than the average market price.

6. SWEAT EQUITY SHARES : The phrase `sweat equity' refers to equity shares given to the company's
employees on favorable terms, in recognition of their work. Sweat equity usually takes the form of
giving options to employees to buy shares of the company, so they become part owners and participate
in the profits, apart from earning salary. This gives a boost to the sentiments of employees and
motivates them to work harder towards the goals of the company.
The Companies Act defines `sweat equity shares' as equity shares issued by the company to employees
or directors at a discount or for consideration other than cash for providing knowhow or making
available rights in the nature of intellectual property rights or value additions, by whatever name called.

7. TRACKING STOCKS:A tracking stock is a security issued by a parent company to track the results of one
of its subsidiaries or lines of business; without having claim on the assets of the division or the parent
company. It is also known as "designer stock". When a parent company issues a tracking stock, all
revenues and expenses of the applicable division are separated from the parent company's financial
statements and bound to the tracking stock. Oftentimes, this is done to separate a subsidiary's high-
growth division from a larger parent company that is presenting losses. The parent company and its
shareholders, however, still control the operations of the subsidiary.

8. DISASTER BONDS: Also known as Catastrophe or CAT Bonds, Disaster Bond is a high-yield debt
instrument that is usually insurance linked and meant to raise money in case of a catastrophe. It has a
special condition that states that if the issuer (insurance or Reinsurance Company) suffers a loss from a
particular pre-defined catastrophe, then the issuer's obligation to pay interest and/or repay the principal
is either deferred or completely forgiven.

Ex- Mexico sold $290 million in catastrophe bonds, becoming the first country to use a World Bank
program that passes the cost of natural disasters to investors. Goldman Sachs Group Inc. and Swiss
Reinsurance Co. managed the bond sale, which will pay investors unless an earthquake or hurricane
triggers a transfer of the funds to the Mexican government.

9.
MORTGAGE BACKED SECURITIES(MBS)
MBS is a type of asset-backed security, basically a debt obligation that represents a claim on the cash
flows from mortgage loans, most commonly on residential property. Mortgagebacked securities
represent claims and derive their ultimate values from the principal and payments on the loans in the
pool. These payments can be further broken down into different classes of securities, depending on the
riskiness of different mortgages as they are classified under the MBS. Kinds of Mortgage Backed
Securities:

A. Commercial mortgage backed securities: backed by mortgages on commercial property Collateralized

mortgage obligation: a more complex MBS in which the mortgages are ordered into tranches by some
quality (such as repayment time), with each tranche sold as a separate security

B. Stripped mortgage backed securities: Each mortgage payment is partly used to pay down the loan's
principal and partly used to pay the interest on it.
C. Residential mortgage backed securities: backed by mortgages on residential property

10. GLOBAL DEPOSITORY RECEIPTS/ AMERICAN DEPOSITORY RECEIPTS

A negotiable certificate held in the bank of one country (depository) representing a specific number of
shares of a stock traded on an exchange of another country. GDR facilitate trade of shares, and are
commonly used to invest in companies from developing or emerging markets. GDR prices are often
close to values of related shares, but they are traded and settled independently of the underlying share.
Listing on a foreign stock exchange requires compliance with the policies of those stock exchanges.
Many times, the policies of the foreign exchanges are much more stringent than the policies of domestic
stock exchange. However a company may get listed on these stock exchanges indirectly – using ADRs
and GDRs. If the depository receipt is traded in the United States of America (USA), it is called an
American Depository Receipt, or an ADR. If the depository receipt is traded in a country other than USA,
it is called a Global Depository Receipt, or a GDR. But the ADRs and GDRs are an excellent means of
investment for NRIs and foreign nationals wanting to invest in India. By buying these, they can invest
directly in Indian companies without going through the hassle of understanding the rules and working of
the Indian inancial market – since ADRs and GDRs are traded like any other stock, NRIs and foreigners
can buy these using their regular equity trading accounts.

11. FOREIGN CURRENCY CONVERTIBLE BONDS(FCCBs)

A convertible bond is a mix between a debt and equity instrument. It is a bond having regular coupon
and principal payments, but these bonds also give the bondholder the option to convert the bond into
stock. FCCB is issued in a currency different than the issuer's domestic currency. The 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. Due to the equity side of the bond, which adds value, the coupon
payments on the bond are lower for the company, thereby reducing its debt-financing costs.

13. DERIVATIVES
A derivative is a financial instrument whose characteristics and value depend upon the characteristics
and value of some underlying asset typically commodity, bond, equity, currency, index, event etc.
Advanced investors sometimes purchase or sell derivatives to manage the risk associated with the
underlying security, to protect against fluctuations in value, or to profit from periods of inactivity or
decline. Derivatives are often leveraged, such that a small movement in the underlying value can cause a
large difference in the value of the derivative.

Derivatives are usually broadly categorised by:

•The relationship between the underlying and the derivative (e.g. forward, option, swap)

•The type of underlying (e.g. equity derivatives, foreign exchange derivatives and credit derivatives)

•The market in which they trade (e.g., exchange traded or over-the-counter)

14. PARTICIPATORY NOTES

Also referred to as "P-Notes" Financial instruments used by investors or hedge funds that are not
registered with the Securities and Exchange Board of India to invest in Indian securities. Indian-based
brokerages buy India-based securities and then issue participatory notes to foreign investors. Any
dividends or capital gains collected from the underlying securities go back to the investors. These are
issued by FIIs to entities that want to invest in the Indian stock market but do not want to register
themselves with the SEBI. RBI, which had sought a ban on PNs, believes that it is tough to establish the
beneficial ownership or the identity of ultimate investors.

15. HEDGE FUND

A hedge fund is an investment fund open to a limited range of investors that undertakes a wider range
of investment and trading activities in both domestic and international markets, and that, in general,
pays a performance fee to its investment manager. Every hedge fund has its own investment strategy
that determines the type of investments and the methods of investment it undertakes. Hedge funds, as
a class, invest in a broad range of investments including shares, debt and commodities. As the name
implies, hedge funds often seek to hedge some of the risks inherent in their investments using a variety
of methods, with a goal to generate high returns through aggressive investment strategies, most notably
short selling, leverage, program trading, swaps, arbitrage and derivatives. Legally, hedge funds are most
often set up as private investment partnerships that are open to a limited number of investors and
require a very large initial minimum investment. Investments in hedge funds are illiquid as they often
require investors keep their money in the fund for at least one year.

16. FUND OF FUNDS

A "fund of funds" (FoF) is an investment strategy of holding a portfolio of other investment funds rather
than investing directly in shares, bonds or other securities. This type of investing is often referred to as
multi-manager investment. A fund of funds allows investors to achieve a broad diversification and an
appropriate asset allocation with investments in a variety of fund categories that are all wrapped up into
one fund.

[Link] TRADED FUNDS

An exchange-traded fund (or ETF) is an investment vehicle traded on stock exchanges, much like stocks.
An ETF holds assets such as stocks or bonds and trades at approximately the same price as the net asset
value of its underlying assets over the course of the trading day. Most ETFs track an index, such as the
S&P 500 or MSCI EAFE. ETFs may be attractive as investments because of their low costs, tax efficiency,
and stock-like features, and single security can track the performance of a growing number of different
index funds (currently the NSE Nifty)

18. GOLD ETF

A gold Exchange Traded Fund (ETF) is a financial instrument like a mutual fund whose value depends on
the price of gold. In most cases, the price of one unit of a gold ETF approximately reflects the price of 1
gram of gold. As the price of gold rises, the price of the ETF is also expected to rise by the same amount.
Gold exchange-traded funds are traded on the major stock exchanges including Zurich, Mumbai,
London, Paris and New York There are also closed-end funds (CEF's) and exchange-traded notes (ETN's)
that aim to track the gold price.

References:-
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