Debt instruments:The type of financial instrument inwhich are undertaken to pay the investor (buyer) a regular amount as interestplus repay the initial amount borrowed is called a debt instrument. Theinterest amount which is required to be paid by the issuer is fixedcontractually.
Therefore, this type of instrument is usually called fixed incomeinstrument.Features ofa Debt instrument:· Debt istruments usuallycarry a fixed rate of interest commited by the issuer.This rate is called as’coupon’.· Company has to pay interestwhether they make profits or not.· Debt securities aretradable.
The person can hold it until maturity or sell it prior to maturity andmake a capital gain (or loss)· Holders of debt instrumentsare not owners of the company .They are its creditors.The creditors may demandcollateral to secure their investment.In this case the instrument is called asa secured debt,else it is unsecured debt.· The face value of a debtinstrument defines the amount to be repaid on maturity.
Classificationof debt securities based on maturity:Long termdebt-instruments-Bonds and Debentures:These areused to raise money for longer duration (more than one year)Bonds:The issuerof the bond promises to pay the bondholder typically a fixed amount of interesteach year for a fixed time period.At the end of that time period (the maturitydate) the issuer promises to pay the bondholder the face value of the bond.It is along term debt securityCoupon rate of a bond:Theoriginal interest rate committed by the issuer at the time security is firstissued is called coupon rate.
Coupon payment can be quarterly or semi annual orannual.Zero coupon bond or discount bond: It is issued at a discountrate to face value and is redeemed at face value.Issuer of bonds:The issueris a corporation or government(state or central)GOI securities:Bondsissued by the Central government in India are called as GOI securities orG-secs (also known as Gilts)The couponon G-sec is paid every 6months( semi-annual coupon)Debentures:It is anunsecured debt instrument which is backed by only the creditworthiness andreputation of the company and not by physical assets and collateral.
The couponrate is higher than that of bonds as debentures are more riskier.Companiescan issue bonds and debentures which are convertible(fully/partly) non-convertibleShort term debt instruments-Money market instruments:These areused to raise money for short duration (less than one year).The money marketinstruments are:1. Treasury bills:These are debt securities backed by government soconsidered virtually default risk- free.2. Certificate of deposits:These are issued by bank or a financialinstitutuion to raise money,similar to fixed deposits3.
Commercial papers:These are unsecured debt instruments of largedenomination issued by a corporation to raise money.As withother debt securities, the holders of these instruments are exposed to most ofthe general risks and particularly interest rate risk, liquidity and creditspread risk.Secondarysecurities:TimedepositsTimedeposits are money deposits that cannot be withdrawn for a certain term ofperiod of time unless a penalty is paid. When the term is over it can bewithdrawn or it can be held for another term.
Generally, speaking, the longerthe term the better the yield on the moneyMutualfundsMutual fundis a mechanism for pooling the resources by issuing units to the investors andinvesting funds in securities in accordance with objectives as disclosed inoffer document.Theperformance of a mutual fund scheme is reflected in its net asset value (NAV)which is disclosed on daily basis in case of open-ended schemes and on weeklybasis in case of close-ended schemes. Net Asset Value is the market value ofthe securities held by the scheme.It varies om day-to-day basis.Insurancepoliciesit means anagreement in which one party agrees to pay a given sum of money upon thehappening of a particular event contingent upon duration of human life in exchangeof the payment of a consideration. The person who guarantees the payment iscalled Insurer, the amount given is called Policy Amount, the person on whoselife the payment is guaranteed is called Insured or Assured. The considerationis called the Premium. The document evidencing the contract is called Policy.
DerivativeinstrumentsTypes of derivatives: 1) forward and futures contracts 2) options 3) swaps