Investment Products - Part 1: Chapter 10: Equity Markets - Part 1

Investment Products - Part 1
A QUALITY E-LEARNING PROGRAM BY WWW.LEARNWITHFLIP.COM
Chapter 10: Equity Markets - Part 1
Capital markets are classified into two categories:
1. Primary Market: Primary market is the market where a financial instrument is first issued/
offered to the public. The interaction is between the issuer and the investor.
2. Secondary Market: Secondary market is the market where the instrument is subsequently
traded (bought and sold). The interaction is between one investor (seller) and another
investor (buyer).
Based on the nature of trading, secondary markets are classified into:
1. Listed Market: Trading where an auction method is used at a physical location, or an

automated mode of trading using Order Matching Systems through an exchange.
For example, stock markets.
2. Over-The-Counter (OTC) or Unlisted Market: A negotiated market without a

physical location where transactions are done via telecommunications. For example,
currency markets.
Trade Life Cycle:

The trade life cycle of a financial instrument has five stages:
1. Issuance:
2. Pre-Trade Analysis:
3. Trade:
4. Post-Trade:
5. Asset Servicing:
Market Participants
Trading participants in the equity markets are classified as follows:
Banks & Brokerage Firms: Banks and brokerage firms are members of stock exchanges. The
exchange interacts with the members, who in turn interact with their clients/investors. Banks
and brokerage firms are said to be on the ‘sell side’.
Fund or Portfolio Managers: Fund or portfolio managers manage accounts of institutions like
mutual funds or of highly wealthy individuals. They are also called asset managers.
Corporates and Individual Investors: These investors are the ones who invest their
surpluses into the capital markets.
Funds/Investment Managers/Corporates /Individuals are said to be on the ‘buy side’.
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Other Market Participants

The other market players who facilitate the post trade process are:
Clearing Firms: A ‘clearing firm’ is an organization that works with the exchanges to handle
confirmation, delivery and settlement of transactions.
Depository: Securities are held in electronic (also called ‘dematerialized’) form in the ‘demat’
(short for dematerialized) accounts at firms providing ‘depository’ services.
Custodian Banks: These are banks where the clients hold their demat accounts. They
facilitate clearing and settlement for the client, by interacting with the broker members,
depositories and clearing corporations.
Exchange: The exchange facilitates trade execution and the clearing and settlement of
securities through their various agencies such as clearing firms.
Regulators: SEBI regulates the stock market to ensure smooth functioning. They also ensure
that investor interests are protected.
System Vendors: These are technology service providers who automate the various processes
and ensure processing with minimal manual intervention.
Key Terms:
1. ADR
This is a negotiable certificate, representing a certain number of shares of a foreign (non US)
company, deposited with an American bank. ADRs or American Depository Receipts can be
traded in the US markets.
2. Bellwether Stock
Bellwether stock has a position of market leadership. Its performance is an indicator, for the
performance of other stocks in the same industry, or the entire market.
3. Book Value
Book Value of a company is the net value of assets – that is, assets minus liabilities - of a
company’s shares.
Shareholders’ fund
Book value =
Number of share issued
4. Bull and Bear Markets
These terms describe how stock markets are doing. That is, whether they are appreciating or
depreciating in value.
Bull market refers to a market, that is on the rise.
Bear market is a steady drop in stock prices, over a period of time.
5. Circuit breakers
Circuit breakers are predefined levels used to curb excessive volatility. They are also known as
‘Price bands’.
6. Face Value
This is the nominal, or stated amount assigned to a security, by the Issuer. It's also known as
‘par value’, or simply ‘par’.
7. FPI/FIIs
Foreign Portfolio or Institutional Investors, are used to denote investors - typically

an institution – registered in a country, other than the one they are investing in.
8. Intrinsic Value
The intrinsic value is a fair value of a share. If the market price of a share is equal to this value,
it is called Fully valued, else it is Over or Under valued.
9. Market Capitalization:
Market cap is calculated using two methods:
‘Full float’– this refers to the total number of equity shares, issued by a company.
‘Free float’ - this is of the number of shares, that are freely traded in the market.
Market Capitalization = Market Price x Number of Outstanding Shares of the

Company
10. Overheated Market
It’s a market situation, where prices are driven up, by a demand supply mismatch.
11. Participatory Notes (P-Notes/PNs)
These are Instruments, issued by registered Foreign Institutional Investors (FIIs) to overseas
investors, who want to invest in the Indian stock market.
12. Short Sale
Short sale is when you sell something, that you do not own. Short selling is allowed intra-
day, on certain securities.
13. Short Squeeze
Short squeeze refers to the pressure on short sellers, to cover their position when the markets
rise sharply, instead of falling, as they expect.
14. Smart Money
Smart money refers to the money invested by people with a more informed knowledge of the
markets.
15. Sunrise Industries
These are new industries which are coming up and growth areas, which are going to play an
important role in the country’s economy.
Trading Philosophy:
1. Top-Down Investing- In this approach, an investor considers important parameters like

 Trends in the economy.
 Industries which these trends favor.
 Companies within these industries which are likely to benefit the most.
This analysis is also called as EIC - Economy, Industry, Company - framework.
2. Bottom-Up Investing- It is the opposite of top-down investing. Bottom-Up investing

involves looking for individual stocks with outstanding performance or potential, without
considering economic or industry trends.
Classification of Stocks:
Stocks are classified into the following categories for trading purposes:
1. Growth Stocks
Growth stocks are stocks that are expected to demonstrate price growth which is better than
the market.
2. Income Stocks
Income stocks are stocks that provide a good dividend yield, on the amount invested.
3. Cyclical Stocks
Cyclical stocks are stocks that are tied to the performance of the economy.
The performance of the companies in these industries drops, as the demand for the stocks of
such companies. The reverse happens, when the economy is booming.
4. Defensive Stocks
Defensive stocks are stocks that are relatively protected from economic cycles. The
demand for these company goods remains relatively stable.
5. Value Stocks
Value stocks are stocks whose current value does not reflect some valuable aspects of the
company. Such stocks are likely to trade at a lower price compared to their fundamentals and
hence must be considered as undervalued by investors.
The advantage of classifying stocks in this manner helps us to decide, what stocks to trade
under different situations.
Chapter 13: Bond Markets - Introduction
A bond is a debt instrument that typically carries a specific rate of interest (called ‘coupon’)
that the bond issuer agrees to pay the bond holder and a promise to repay the principal on
maturity.
Key Terms:
Coupon: It is the interest rate the issuer contracts to pay, in the primary market.
Types of coupon: Level Coupon, Floating Coupon and Zero Coupon.
Yield: It is the return on the amount invested.

Note: The coupon of a bond remains the same throughout its life; but the yield keeps
changing based on prevailing market price.
The two types of yield are:

Current Yield: This is a rough calculation of yield, or return on investment which considers
only the coupon.
Current Yield = (Annual Coupon Amount (in INR)/ Current Market Price) * 100
Yield To Maturity (YTM): It is the total return on investment if held till maturity. YTM
considers coupon, principal payment, and the reinvestment return of the coupon.
Yield Curve: It gives the relationship between interest rate and term to maturity, at a
specified time.
Types: Positive Yield Curve, Negative Yield Curve, Flat Yield Curve.
Floating Interest Rates: If the coupon on a bond is varied at periodic intervals, it is known
as Floating.
The most popular international benchmark rate is LIBOR.
LIBOR stands for London Inter - Bank Offer Rate.
1. London: It is a rate determined in London.
2. Inter – Bank: It is a rate between banks.
3. Offer Rate: It is the rate at which one bank is willing to offer (lend) money to another
bank.
Credit Rating: There are credit rating agencies who have the expertise to evaluate this risk.
Credit quality ratings are denoted by assigning a letter rating to an issue, such as AAA, AA+,
AA, AA-, BBB+…. , C, D etc.
AAA - Denotes highest credit safety, D - Denotes lowest credit safety.
Chapter 14: The Indian Bond Markets
Bonds in India can be classified as follows:
Bonds - Basis type of Issuer:
Government
Instruments State Securities Corporate Bonds
Securities
Yield Low Medium High

Riskier than State
Risk Lowest Riskier than G-Secs
Securities
Institutional players, Institutional players,
individuals only individuals only Institutional players,
Investors
through mutual through mutual individuals
funds funds
To fund For funding
Use of To fund State's own
Government's fiscal expansion plans,
Funds projects
deficit specific projects
Day Count
30/360 30/360 Act/365
Convention
Bonds - Basis Characteristics:
Instruments Exercise Condition Pricing

Exercised by the issuer when the Price is calculated using the lowest
Callable Bonds market yield is lower than the coupon. yield among all the exercisable
dates.
Price is calculated as for a normal
Exercised by the investor when the
Puttable Bonds bond, the put option is given as a
market yield than the coupon.
bonus.
Price is calculated as a normal

Callable/ One of the above take place on
bond. Maturity is taken as time to
Puttable Bond specific date.
first option date.
Exercised by the investor when the Price is calculated as for a normal

Convertible
investor of the stock is higher than bond and the option price is netted
Bond
the preset conversion price. off from the price.
Money Market Instruments
Money market securities are also bonds, but with short tenor, i.e. less than 1 year.
Treasury Bills, discussed earlier, are money market instruments.
The other money market instruments are:
1. Certificates of Deposit (CDs): CDs are issued by banks to raise funds.
Features:
 Interest paid : Either on maturity or periodically
 Trading platform : Secondary market
 Interest rate : Depends on the credit rating of the issuer and the market
liquidity.
2. Commercial Paper (CPs): CP is an unsecured money market instrument issued by
corporates to raise money.
Features:
 Issued at: Discount to face value i.e., they are zero coupon instruments.
 Who can issue: Only corporates who get the required rating can issue
CPs.
 Maturity: Minimum of 15 days maximum of one year.
3. Repurchase Agreements (Repos)
Repos are traded on call money market.
Call Money Market: The most liquid tenor for borrowing and lending transactions
remains the overnight market, which is called the call money market in India.
Ready forward transaction or ‘Repo’ is a money market instrument, which enables

secured short term borrowing and lending through sale or purchase of debt instruments.
RBI uses the repo as an instrument of monetary policy i.e., to signal interest rate
changes. RBI publishes a 1 day repo and reverse repo rate daily.
Repo rate is the rate at which RBI is willing to lend money to other banks against
government securities.
The reverse repo rate is the rate at which RBI is willing to borrow money from other
banks against government securities.
Collateralised Borrowing and Lending Operation (CBLO)
Other participants like mutual funds and corporates, with surplus liquidity, can
participate in call money market through the Collateralized Borrowing and Lending
Operation (CBLO) of the Clearing Corporation of India Ltd. (CCIL).
Bond Markets - Regulations
Market Regulator Description

Primary
1. RBI 1. Responsibility of primary market regulation.
Market
1. RBI 1. Sale and purchase of the G-Secs and other
Secondary money market securities.
Market
2. SEBI 2. Any transactions done on the stock exchange.
Market Players
 Primary Dealers: They can also be referred to as ‘Merchant Bankers’ to the

Government of India as only they are allowed to underwrite primary issues of
government securities.
 PSU Bank: These banks are normally lenders in the call money market,
 Private Banks: They have very active treasuries. They tend to be borrowers in the call
money market.
 Co-operative Banks: These banks have small requirements and are typically buyers of
debt securities, particularly Government debt, to meet statutory requirements.
 Foreign Banks: These are the Indian subsidiaries of multinational banks.

These banks have very aggressive treasuries, and are typically borrowers in the call
money market.
 Insurance Companies:
These players are normally investors, and practice a buy and hold strategy. They
tend to buy longer term bonds (10-20 years) to match their insurance liability
profile.
 Mutual Funds: They operate various schemes and their role in the market is
determined by these various schemes’ philosophy.
 FIIs and Hedge Funds: Foreign investors primarily trade in equities. They also do
arbitrage trades between the foreign exchange and money markets.
Chapter 15: Introduction to Derivatives
Financial Derivative
A Derivative is a financial instrument, that derives its value, from the value of another basic
underlying instrument, or variable.
The financial markets trade in a bewildering array of Non-derivative and Derivative products.
The Building Blocks
All financial products can be broken down, into a combination of three basic financial products:
Credit Extension Products: These are forms of extending credit or loans.
Price Fixing Products: These are financial products that, fix the price at which an exchange
of value takes place, at a future date.
Value of a Price Fixing product = Function (Current/Market Price, Price Fixed)

The P/L equation is therefore, as shown:
P/L = (Market Price – Contract Price) x Amount Purchased
There are three types of price fixing products:
 Forward Contracts , or Forwards
 Future Contracts , or Futures
 Swaps
Price Insurance Products

These products give the owner the right, but not the obligation, to exchange value at a future
date, at a pre-determined price today.
As the owner of a price insurance contract, you can either exercise your right, or walk
away.
The Profit/Loss formula will be:

Profit/Loss = Maximum of (price of underlying, 0) – Premium paid
Key Terms:
Open Interest
The total amount of long or short positions, in terms of quantity in a particular contract, is
called the Open Interest (OI), in the contract.
Open Interest indicates:
a) The amount of trading that has taken place in a contract.

b) The number of contracts outstanding for that delivery (long or short).
Note: OI is an indicator of liquidity in the market, on that tenor.
Margins: Margins are used by Exchanges, to reduce the credit risk associated with
derivative contracts.
This security deposit or margin ensures that in case the participant defaults, there is enough
money to compensate the other party, for any loss.
Types of Margins
 Initial Margin - This is a percentage of the transaction value
 Additional Margin - This is the margin collected to protect open positions, in case of any
unexpected volatility prevailing in the market.
 Premium Margin - It is the amount of premium to be paid upfront. The premium

margin is the only margin payable by the buyer of the contract.
 Mark to Market (MTM) Margin - This is calculated as the difference between the
closing price and the contracted price.
Mark to Market Margin = Closing Price – Contracted Price
Chapter 16: Equity Futures
A Futures contract fixes the price at which a standard amount of the asset is exchanged, at
a pre-defined price, on a standard expiry date in the future.
Key Terms
i. Underlying instrument: The instrument on which the contract is fixed.

ii. Exchange: Futures contracts are traded on a Futures Exchange (NSE/BSE) through
member brokers.
iii. Contract size/Market Lot: The number of shares in the Futures contract.
iv. Trading Months: Futures contracts have a maximum of a 3month trading cycle.
v. Expiry: The futures contracts expire on the last Thursday, of the delivery month.
Note: At any point in time, there will be 3 contracts available for trading in the market - i.e.,
one near month, one mid month and one far month duration, respectively.
Trading Equity Futures
1. Place the order by making an upfront deposit i.e., the Margin -with the broker.
2. Once the Margin is deposited, the broker will route the order to the Exchange.
3. The trade gets executed through the Exchange, just like stocks.
Types of Margins
1. Initial Margin or SPAN Margin: This is a percentage of transaction value.

2. Exposure Margin: This is an additional margin calculated on the value of the exposure
taken.
3. Mark to Market Margin: The profit or loss on the contract is calculated daily, at the end
of each trade day.
P/L = (Market Price – Contract Price) x Amount Purchased
The profit/loss has to be paid to the broker, who in turn, will pay the Exchange Clearing House.
This profit/loss is termed as the ‘Mark to Market Margin’. It is payable, before trading opens
the next day.

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Investment Products - Part 1

A QUALITY E-LEARNING PROGRAM BY WWW.LEARNWITHFLIP.COM

Chapter 10: Equity Markets - Part 1

Capital markets are classified into two categories:

Based on the nature of trading, secondary markets are classified into:

1. Listed Market: Trading where an auction method is used at a physical location, or an

2. Over-The-Counter (OTC) or Unlisted Market: A negotiated market without a

Trade Life Cycle:

Funds/Investment Managers/Corporates /Individuals are said to be on the ‘buy side’.

Other Market Participants

Chapter 11: Equity Markets - Part 2

4. Bull and Bear Markets

Foreign Portfolio or Institutional Investors, are used to denote investors - typically

Market cap is calculated using two methods:

Market Capitalization = Market Price x Number of Outstanding Shares of the

10. Overheated Market

11. Participatory Notes (P-Notes/PNs)

12. Short Sale

13. Short Squeeze

14. Smart Money

15. Sunrise Industries

Chapter 12: Equity Markets - Part 3

1. Top-Down Investing- In this approach, an investor considers important parameters like

2. Bottom-Up Investing- It is the opposite of top-down investing. Bottom-Up investing

Chapter 13: Bond Markets - Introduction

Yield: It is the return on the amount invested.

The two types of yield are:

Chapter 14: The Indian Bond Markets

Bonds in India can be classified as follows:

Bonds - Basis type of Issuer:

Yield Low Medium High

Bonds - Basis Characteristics:

Instruments Exercise Condition Pricing

Price is calculated as a normal

Exercised by the investor when the Price is calculated as for a normal

Money Market Instruments

Treasury Bills, discussed earlier, are money market instruments.

The other money market instruments are:

1. Certificates of Deposit (CDs): CDs are issued by banks to raise funds.

Repos are traded on call money market.

Ready forward transaction or ‘Repo’ is a money market instrument, which enables

Collateralised Borrowing and Lending Operation (CBLO)

Bond Markets - Regulations

Market Regulator Description

 Primary Dealers: They can also be referred to as ‘Merchant Bankers’ to the

 Foreign Banks: These are the Indian subsidiaries of multinational banks.

Chapter 15: Introduction to Derivatives

Credit Extension Products: These are forms of extending credit or loans.

Value of a Price Fixing product = Function (Current/Market Price, Price Fixed)

Price Insurance Products

The Profit/Loss formula will be:

Open Interest indicates:

a) The amount of trading that has taken place in a contract.

Note: OI is an indicator of liquidity in the market, on that tenor.

 Initial Margin - This is a percentage of the transaction value

 Premium Margin - It is the amount of premium to be paid upfront. The premium

Mark to Market Margin = Closing Price – Contracted Price

Chapter 16: Equity Futures