7.

FINANCIAL INSTRUMENTS

INTRODUCTION :
The products which are traded in the Financial Markets are called Financial
Instruments.
Based on the different requirements and needs of the credit seeker, the securities
in the market also differ from each other.
A financial instrument is defined as a contract between individuals/parties that
holds a monetary value. They can either be created, traded, settled, or modified
as per the involved parties' requirement. In simple words, any asset which holds
capital and can be traded in the market is referred to as a financial instrument.

CHARACTERISTICS/ FEATURES OF EQUITY SHARES :

1) They are permanent in nature.
2) Equity shareholders are the actual owners of the company and they bear the
highest risk.
3) Equity shares are transferable, i.e. ownership of equity shares can be
transferred with or without consideration to other person.
4) Dividend payable to equity shareholders is an appropriation of profit.
5) Equity shareholders do not get fixed rate of dividend.
6) Equity shareholders have the right to control the affairs of the company.
7) The liability of equity shareholders is limited to the extent of their
investment.

ADVANTAGES OF EQUITY SHARES :

Equity shares are amongst the most important sources of capital and have
certain advantages which are mentioned below :
From the Company's Point of View,
1. They are a permanent source of capital as such; and do not involve any
repayment liability.
2. They do not have any obligation regarding payment of dividend.
3. Larger equity capital base increases the creditworthiness of the company
among the creditors and investors.
From the Shareholders' Point of View,
1. Equity shares are very liquid and can be easily sold in the capital market.
2. In case of high profit, they get dividend at higher rate.
3. Equity shareholders have the right to control the management of the
company.
4. The equity shareholders get benefit in two ways, yearly dividend and
appreciation in the value of their investment.

DISADVANTAGES OF EQUITY SHARES :

From the Company's Point of View:
1. Cost of equity is the highest among all the sources of finance.
2. Payment of dividend on equity shares is not tax-deductible expenditure.
3. As compared to other sources of finance, issue of equity shares involves
higher floatation expenses of brokerage, underwriting commission, etc.
From the Shareholders' Point of View:
1. Equity shareholders get dividend only if there remains any profit after
paying debenture interest, tax and preference dividend. Thus, getting
dividend on equity shares is uncertain every year.
2. Equity shareholders are scattered and unorganized, and hence they are
unable to exercise any effective control over the affairs of the company.
3. Equity shareholders bear the highest degree of risk of the company.
4. Market price of equity shares fluctuate very widely which, in most
occasions, erode the value of investment.
5. Issue of fresh shares reduces the earnings of existing shareholders.

TYPES OF EQUITY SHARES :

1. Ordinary Shares : Ordinary shares are those shares a company issues to
raise funds to meet long term expenses. Investors get part ownership of the firm.
It is to the tune of the number of shares held by then. An ordinary shareholder
will have voting rights.
2. Preference Shares : Preference equity shares are an assurance of the
payment of a cumulative dividend to investors before ordinary shareholders. On
the other hand, preference shareholders lack the voting and membership rights
of a common shareholder. Preference shares are classified as participating or
non-participating. If an investor purchases participation preference shares, they
get a specified amount of profits as well as bonus returns. These benefits are
subject to the company’s success in a specific financial year. Non-participating
equity shareholders do not get any such benefits. Furthermore, preference
shareholders receive repayment of capital when the company is dissolving or
winding up its business.
3. Bonus Shares : Bonus shares are a type of equity shares a company issues
from its retained earnings. In other words, a company’s distributes its profits in
the form of a bonus issue. However, this doesn’t increase the company’s market
capitalization, like how other equity shares do.
4. Rights Shares : Rights shares are not for everyone. The company issues
these shares only for specific premium investors. As a result, the equity stake of
such holders increases. The rights issue is done at a discounted price. The
motive is to raise money to meet financial requirements.
5. Sweat Equity : Directors and employees of a company receive sweat equity
shares. They get the shares at a discount for their excellent work in providing
intellectual property rights, know-how, or value additions to the company.
6. Employee Stock Options (ESOPs) : A company gives ESOPs to its
employees as an incentive and as a retention strategy. Employees are given the
option to purchase shares at a predetermined price at a future date under the
terms of an ESOP. Employees and directors who exercise their ESOP grant
option receive these shares.

CLASSES OF STOCKS :
Class A Shares : When a company makes its initial public offering (IPO), Class
A shares are issued. Common stock or shares are other names for these shares.
More weight than any other share class issued by the company, this class of
shares has voting rights within the corporation. Investors who purchase Class A
shares are qualified to receive a portion of the company's profits. These
shareholders have the right to express their issues, ideas, and proposals during
the annual meetings the firm has. When the business generates strong returns,
these investors also receive a portion of the dividends. These shareholders
receive payment first even during the liquidation.
Class B shares : Class B shares have fewer voting rights in corporate concerns
than Class A shares, in contrast. They resemble shares that are second-best with
fewer advantages. These shares have a relatively modest front-end burden.
Additionally, if and only if they keep them for a lengthy period of time,
investors are not required to pay any back-end load.
A front-end load is a commission or sales charge applied at the time of the
initial purchase of an investment. When an investor exits or sells a mutual fund,
they need to pay a certain amount of commission or fee which is called as Back
End Load. This is also known as an exit load. It is not applicable to all fund
houses.

STOCK SPLITS :
A stock split is a corporate action in which a company divides its existing shares
into multiple shares to boost the liquidity of the shares.
All the public companies that are listed on stock exchanges have a definite
number of outstanding shares available for trading.
A stock split is a decision taken by the board of directors of a company to divide
its existing shares into multiple shares. In simple words, The process of dividing
the outstanding shares into further smaller shares is known as stock splits.
In this the market value of the total outstanding shares of a company remains
the same but market value of a single share is reduced in proportion to the no of
shares extracted out of a single share.
Thus, although the number of shares outstanding increases by a specific
multiple, the total value of the shares remains the same compared to pre-split
amounts, because the split does not add any real value.
The most common forward split ratios are 2-for-1 or 3-for-1, which means that
the stockholder will have two or three shares for every share held earlier.

REVERSE STOCK SPLITS :

1. A reverse stock split is a corporate action that reduces the number of
outstanding shares of a public corporation. The aim of this is to increase the
price per share, which a company might need to do to meet exchange listing
rules or make it easier to raise money from new investors.
2. Reverse stock splits are typically used by companies whose stock price has
fallen to a level that makes it difficult to attract investors and meet listing
requirements for stock exchanges.
3. By reducing the number of outstanding shares, a reverse stock split can
increase the price per share, making the stock more appealing to investors and
potentially improving the company's financial standing.
4. For example, let's say Company XYZ's stock is trading at $1 per share, and
the company decides to do a 1-for-10 reverse stock split. This means that for
every 10 shares of stock an investor owns, they will receive one new share.
5. After the reverse stock split, the number of outstanding shares will be reduced
by a factor of 10, and the price per share will increase to $10 - that’s the theory
anyway.

DIVIDEND :
A portion of a company's profit paid to shareholders. Public companies that pay
dividends usually do so on a fixed schedule although they can issue them at any
time. Unscheduled dividend payments are known as special dividends or extra
dividends.
A dividend is the distribution of corporate earnings to eligible shareholders.
Dividend payments and amounts are determined by a company's board of
directors.
The dividend yield is the dividend per share, and expressed as a percentage of a
company's share price.
A dividend is a reward paid to the shareholders for their investment in a
company’s equity, and it usually originates from the company's net profits.
Though profits can be kept within the company as retained earnings to be used
for the company’s ongoing and future business activities, a remainder can be
allocated to the shareholders as a dividend.
Companies may still make dividend payments even when they don’t make
suitable profits to maintain their established track record of distributions.
EX-DIVIDEND :
Ex-dividend describes a stock that is trading without the value of the next
dividend payment. The ex-dividend date or "ex-date" is the day the stock starts
trading without the value of its next dividend payment.
Typically, the ex-dividend date for a stock is one business day before the record
date, meaning that an investor who buys the stock on its ex-dividend date or
later will not be eligible to receive the declared dividend. Rather, the dividend
payment is made to whoever owned the stock the day before the ex-dividend
date.
Ex-dividend is when a company's dividend allocations have been specified.
The ex-dividend date of a stock is the day on which the stock begins trading
without the subsequent dividend value.
Investors who purchased the stock before the ex-dividend date are entitled to the
next dividend payment while those who purchased the stock on the ex-dividend
date, or after, are not.
The ex-dividend date occurs before the record date because a stock trade is
settled "T+1" meaning that the record of that transaction isn't settled for one
business day.

DRIPS :
The word DRIP is an acronym for "dividend reinvestment plan", but DRIP also
happens to describe the way the plan works. With DRIPs, the cash dividends
that an investor receives from a company are reinvested to purchase more stock,
making the investment in the company grow little by little.
A DRIP is a dividend reinvestment plan whereby cash dividends are reinvested
to purchase more stock in the company.
DRIPs help investors accumulate additional shares at a lower cost since there
are no commissions or brokerage fees.
A dividend is a reward to shareholders, which can come in the form of a cash
payment that is paid via a check or a direct deposit to investors. DRIPs allow
investors the choice to reinvest the cash dividend and buy shares of the
company's stock.
TREASURY STOCKS :
Shares that have been issued to the public in the primary market and then
repurchased by a company from its own shareholders in the secondary market
are referred to as a treasury shares because they are returned to the treasury of
the company.
These shares have no voting rights, receives no dividends and not used in the
computation of earnings per share in the corporation’s financial records.
Effect of Having the Treasury Stock on the Company :
One cannot derive any voting rights or receive dividends on the treasury stock.
However, the main advantage associated with this is that the company can limit
outside ownership and reserve it for circumstances where additional capital is to
be raised in the future.
In the short term, adding treasury stock weakens the balance sheet of the
company. This is because the company has to pay for its own stock through an
asset, thereby reducing the overall equity amount.
The treasury stock cannot be included in the calculation of outstanding shares of
the company.
In case the company liquidates, then the treasury stock will not draw out any
portion of the net assets for itself.

DEPOSITORY RECEIPTS :
A depositary receipt (DR) is a negotiable certificate issued by a bank. It
represents shares in a foreign company traded on a local stock exchange and
gives investors the opportunity to hold shares in the equity of foreign countries.
It gives them an alternative to trading on an international market.
A depositary receipt was originally a physical certificate that allowed investors
to hold shares in the equity of other countries. One of the most common types of
DRs is the American depositary receipt (ADR), which has been offering
companies, investors, and traders global investment opportunities since the
1920s.
A depositary receipt (DR) is a negotiable certificate representing shares in a
foreign company traded on a local stock exchange.
Depositary receipts allow investors to hold equity shares of foreign companies
without the need to trade directly on a foreign market.
Depositary receipts allow investors to diversify their portfolios by purchasing
shares of companies in different markets and economies.
Depositary receipts are more convenient and less expensive than purchasing
stocks directly in foreign markets.

RISK RETURN TRADE-OFF :

Risk-return trade-off states that the potential return rises with an increase in risk.
Using this principle, individuals associate low levels of uncertainty with low
potential returns, and high levels of uncertainty or risk with high potential
returns.
Risk-return trade-off states that the potential return rises with an increase in risk.
Using this principle, individuals associate low levels of uncertainty with low
potential returns, and high levels of uncertainty or risk with high potential
returns.
According to risk-return trade-off, invested money can render higher profits
only if the investor will accept a higher possibility of losses.
Risk-return trade-off is an investment principle that indicates that the higher the
risk, the higher the potential reward.
To calculate an appropriate risk-return trade-off, investors must consider many
factors, including overall risk tolerance, the potential to replace lost funds, and
more.
Investors consider risk-return trade-off on individual investments and across
portfolios when making investment decisions.

TECHNIQUES FOR MANAGING RISK-RETURN :

Risk management helps cut down losses. It can also help protect traders'
accounts from losing all of its money. The risk occurs when traders suffer
losses. If the risk can be managed, traders can open themselves up to making
money in the market.
It is an essential but often overlooked prerequisite to successful active trading.
After all, a trader who has generated substantial profits can lose it all in just one
or two bad trades without a proper risk management strategy.
Trading can be exciting and even profitable if traders are able to stay focused,
do due diligence, and keep emotions at bay.
Still, the best traders need to incorporate risk management practices to prevent
losses from getting out of control.
Having a strategic and objective approach to cutting losses through stop orders,
profit taking, and protective puts is a smart way to stay in the game.
There various techniques for managing risk-return
1. Diversification 2. Asset Allocation

1. Diversification :
Diversification is a risk management strategy that creates a mix of various
investments within a portfolio. A diversified portfolio contains a mix of distinct
asset types and investment vehicles in an attempt to limit exposure to any single
asset or risk.
The rationale behind this technique is that a portfolio constructed of different
kinds of assets will, on average, yield higher long-term returns and lower the
risk of any individual holding or security.
Diversification is a strategy that mixes a wide variety of investments within a
portfolio in an attempt to reduce portfolio risk.
Diversification is most often done by investing in different asset classes such as
stocks, bonds, real estate, or cryptocurrency.
Diversification can also be achieved by purchasing investments in different
countries, industries, sizes of companies, or term lengths for income-generating
investments.
The quality of diversification in a portfolio is most often measured by analysing
the correlation coefficient of pairs of assets.
Investors can diversify on their own by investing in select investments or can
hold diversified funds.
2. ASSET ALLOCATION :
Asset allocation is an investment strategy that aims to balance risk and reward
by apportioning a portfolio's assets according to an individual's goals, risk
tolerance, and investment horizon. The three main asset classes—equities,
fixed-income, and cash and equivalents—have different levels of risk and
return, so each will behave differently over time.
Asset allocation is an investment strategy that aims to balance risk and reward
by apportioning a portfolio's assets according to an individual's goals, risk
tolerance, and investment horizon.
The three main asset classes—equities, fixed-income, and cash and
equivalents—have different levels of risk and return, so each will behave
differently over time.
There is no simple formula that can find the right asset allocation for every
individual.